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

Which combination best explains why the dollar shortage became a global rather than a purely US phenomenon during the 2007-2009 crisis?

The shortage was global because the dollar is the main funding currency, and foreign banks with big dollar balance sheets had no dollar lender of last resort. Counterparty distrust froze money and swap markets, so these banks could not roll over dollar funding, spreading stress worldwide.

  1. AUS banks stopped lending dollars to US households only, leaving foreign banks unaffected
  2. BThe dollar's role as the main funding and invoicing currency meant foreign banks with large dollar balance sheets but no dollar lender of last resort faced runs in dollar markets, and counterparty distrust impaired money markets and swap marketsCorrect
  3. CForeign central banks had unlimited dollar reserves but chose not to lend them
  4. DDollar depreciation sharply reduced the dollar value of foreign banks' liabilities

Explanation

Foreign banks relied on dollar wholesale funding, yet their home central banks could not create dollars. Counterparty fears froze interbank and swap markets, causing a worldwide shortage. The depreciation option is wrong because the dollar generally strengthened during the stress, raising the burden of dollar debts.

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