Address FBO Reserve Demand via
Swap Lines & Foreign Coordination

Why FBOs Hold Excess Reserves

Foreign Banking Organizations (FBOs) — U.S. branches and subsidiaries of foreign banks — hold a disproportionately large share of total reserve balances relative to their balance sheet size. Research suggests FBOs hold roughly 20–25% of aggregate reserves despite accounting for a smaller share of total U.S. bank assets. This excess reserve concentration is not primarily driven by U.S. liquidity regulations (though the FBO-IORB arbitrage described in Option 07 is relevant), but by the dollar funding risk management frameworks of foreign parent banks.

The core dynamic: foreign banks — particularly European banks — have significant dollar-denominated liabilities on their home balance sheets (dollar bonds, dollar-funded loans, dollar derivatives). These dollar liabilities create a structural need for dollar liquidity that can be met by their U.S. branches holding reserve balances at the Fed. The alternative — accessing dollar liquidity via FX swap markets from their home currency — is reliable in normal times but historically unreliable in stress (as seen dramatically in 2008 and 2020).

Swap Lines as a Substitute

The Federal Reserve maintains standing swap lines with the Bank of Canada, Bank of England, Bank of Japan, European Central Bank, and Swiss National Bank. In a dollar funding stress event, these central banks can borrow dollars from the Fed and on-lend them to their domestic banks, providing a reliable dollar liquidity channel that does not require foreign banks to hoard reserves in their U.S. branches.

However, two features undermine the effectiveness of swap lines as a substitute for precautionary reserve holdings. First, their permanence is not guaranteed: the standing swap lines were made permanent only in 2013, and there remains theoretical uncertainty about whether they would be renewed in future crises or political environments. Second, swap line access is at the central bank level — individual commercial banks cannot access their central bank's swap line directly; they must borrow from their national central bank, which introduces an additional intermediation step and potential stigma.

The Policy Option

A public, permanent, treaty-level commitment to swap line availability — removing uncertainty about future renewal — would reduce the option value of precautionary dollar reserve holdings by FBOs. If foreign banks were confident their home central bank could always provide dollar liquidity via the swap line in a stress event, their need to pre-position reserves in their U.S. branches would diminish.

Complementarily, regulatory coordination with foreign supervisors — particularly the ECB, Bank of England, and Bank of Japan — could encourage foreign regulatory frameworks to credit swap line access as a liquidity source in their own stress tests and liquidity requirements. If the ECB formally allowed German or French banks to count swap line access as a dollar liquidity buffer, those banks' U.S. branches would have less need to hold dollar reserves as a parallel precautionary measure.

Political Complexity

Making swap lines treaty-level commitments involves complex international negotiations and potential Congressional scrutiny. The paper acknowledges this is among the most diplomatically complex options in the guide. As a practical matter, a strong public statement by Fed leadership — committing to maintain swap lines and reiterating their role in U.S. financial stability — could achieve some of the same credibility effect at lower political cost, even without formal treaty status.