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FRM Part II · FRM Exam Part II · The US Dollar Shortage in Global Banking and the International Policy Response

During the 2007-09 crisis, the Federal Reserve established temporary US dollar liquidity swap lines with several foreign central banks. What was the primary mechanism by which these swap lines relieved dollar funding stress at banks outside the United States?

The foreign central bank swaps its own currency for dollars with the Fed and then lends those dollars to its domestic banks. The Fed faces only the foreign central bank, not the commercial banks, so dollar liquidity reaches stressed banks without the Fed taking their credit risk.

  1. AThe Fed lent dollars directly to foreign commercial banks against their local-currency assets
  2. BThe foreign central bank received dollars from the Fed in exchange for its own currency and lent those dollars to its domestic banksCorrect
  3. CForeign central banks sold their US Treasury holdings to raise dollars in the open market
  4. DThe Fed purchased foreign banks' dollar-denominated securities to support their prices

Explanation

Under a swap line, the Fed exchanges dollars for foreign currency at the prevailing exchange rate with the foreign central bank, which then on-lends the dollars to banks in its jurisdiction. The Fed does not lend to foreign commercial banks directly; the foreign central bank bears the credit risk of its banks. Selling Treasuries is a separate reserve-use channel, not the swap line mechanism.

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