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

The Federal Reserve responded to the 2007-2009 dollar shortage in part by establishing central bank liquidity swap lines with foreign central banks. How did these lines relieve the shortage?

The Fed exchanged dollars with foreign central banks for their own currencies, and those central banks lent the dollars to their domestic banks. This gave non-US banks a dollar backstop without the Fed lending to them directly, easing the shortage and narrowing the cross-currency basis.

  1. AThe Fed lent dollars directly to commercial banks in all countries without any counterpart central bank
  2. BForeign central banks received dollars from the Fed against their own currency and lent them onward to their domestic banksCorrect
  3. CThe Fed purchased the foreign banks' US structured credit assets at par
  4. DThe swap lines fixed exchange rates between the dollar and foreign currencies

Explanation

Under swap lines, the Fed provided dollars to a foreign central bank in exchange for its currency; that central bank then lent the dollars to banks in its jurisdiction, taking on the credit risk of its own banks. This served as a dollar backstop outside the US. The other options misdescribe the arrangement.

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