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

Which feature of non-US banks' business model best explains why they could not simply use home-currency liquid assets to cover dollar funding gaps during the crisis?

Dollar liabilities must be settled in dollars, and banks holding only home-currency liquid assets had to convert them through FX swap or spot markets that were impaired. Liquidity is therefore currency-specific, leaving banks exposed to a dollar shortfall despite ample domestic liquidity.

  1. ADollar liabilities must be met in dollars, and converting home currency required the FX swap market, which was impairedCorrect
  2. BHome-currency assets are illiquid by regulation
  3. CCentral banks forbid banks from holding foreign currency
  4. DUS regulation requires all dollar liabilities to be repaid in euros

Explanation

Liquidity is currency-specific. Obligations denominated in dollars require dollars, and obtaining them from euro or yen holdings depended on spot or swap markets that were stressed. This is why central bank swap lines were later established.

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