Worried about Trump cutting off the Federal Reserve's dollar financing, the European Central Bank requires banks to prepare for a crisis

The European Central Bank (ECB) regulators are forcing banks in the region to prepare for an unprecedented crisis scenario: the Federal Reserve may refuse to provide dollar liquidity support in emergencies.

On Wednesday, media reports indicated that ECB regulators are requiring some eurozone banks to assess the demand for dollars under stress scenarios, simulating a situation where they cannot rely on the Federal Reserve for dollars under the Trump administration. Three informed sources revealed that regulators are treating this issue as urgent.

Approximately 17% of eurozone banks' financing needs are denominated in dollars, and these banks primarily obtain dollars through the U.S. short-term financing market, where the supply of dollars may suddenly close during periods of financial stress, making this concern particularly serious amid ongoing trade frictions.

An executive from a large European bank stated that their bank's risk assessment for the scenario of "Federal Reserve financing potentially being unavailable" has risen from 0% a few months ago to 5%, which is a "significant" level of risk. Another executive from a European bank regulated by the ECB revealed that their bank recently modeled the tricky scenario of "Federal Reserve swap lines being unavailable" for the first time. While the bank can maintain trading in the long term, new dollar business would incur significant costs.

ECB regulators are asking some regional banks to narrow the gaps on their balance sheets and consider making adjustments to reduce reliance on dollar financing.

Liquidity Gaps Become a Focus

European regulators are requiring banks to assess the gaps in their balance sheets, such as lending dollars to customers or financing other dollar-denominated assets without sufficient or reliable dollar funding to meet liabilities. Regulators are urging some eurozone banks to reduce such gaps and, in some cases, asking them to consider changing parts of their business to reduce exposure to dollar financing.

In the financial stability assessment from last November, it was pointed out that 17% of eurozone banks' funding is in dollars, primarily sourced from U.S. financing markets, such as commercial paper and overnight repurchase agreements. However, these funding sources may dry up during stress events, and despite the Federal Reserve being independent from the White House, Trump's frequent public criticism of Powell has raised concerns about a potentially less independent Federal Reserve in the future.

According to a previous report by Deutsche Bank, the Federal Reserve's dollar swap lines are a key tool for maintaining global financial stability, far more influential than tariffs. The dollar swap mechanism controls a foreign exchange swap market worth approximately $97 trillion, equivalent to the total global GDP. If Trump targets the Federal Reserve's dollar swap as a "nuclear button"—refusing to provide dollar liquidity at critical moments—it could trigger a severe global financial crisis.

Currently, in some cases, European banking regulators have asked banks to consider changing their business models, allowing banks to reduce dollar-denominated liabilities by scaling back activities in certain markets or business lines