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FRM Part II · FRM Exam Part II · Managing Nondeposit Liabilities

A bank funds a 5-year loan portfolio of USD 400 million with USD 300 million of overnight repos and USD 100 million of equity. The bank must roll the repos every day. Which risk is most directly heightened by this funding structure?

The main risk is rollover or refinancing risk. Funding five-year loans with overnight repos creates a severe maturity mismatch, so the bank must refinance USD 300 million every day and could face a funding gap if lenders withdraw or raise haircuts.

  1. ARollover (refinancing) risk arising from the maturity mismatch between assets and liabilitiesCorrect
  2. BReinvestment risk on the equity portion only
  3. CSettlement risk due to long-dated loan maturities
  4. DBasis risk between the loan rate and the repo rate being exactly zero

Explanation

Funding long-dated assets with overnight liabilities means the bank must refinance daily, so any market disruption or haircut increase can leave it unable to fund. Reinvestment and settlement risk are not the main issue, and basis risk is not zero by construction.

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