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

In a central bank dollar swap line, the foreign central bank receives dollars from the Fed and lends them to its domestic banks. Who bears the credit risk on the loans to the commercial banks?

The foreign central bank bears the credit risk on loans to its domestic banks. The Fed's counterparty is that central bank, which must return the dollars at the contracted rate regardless of whether its borrowers repay, and the Fed holds the foreign currency as collateral.

  1. AThe Federal Reserve, because it supplies the dollars
  2. BThe foreign central bank, which is the lender to its domestic banks and owes the Fed repayment regardlessCorrect
  3. CThe commercial banks' US depositors
  4. DThe US Treasury through the Exchange Stabilization Fund

Explanation

The Fed's counterparty is the foreign central bank, and it holds the foreign currency as collateral at a fixed exchange rate. The foreign central bank takes the credit risk of its domestic borrowers. The Fed is therefore not exposed to the commercial banks directly.

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