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FRM Part II · FRM Exam Part II · The Failure Mechanics of Dealer Banks

A dealer bank has USD 40 billion of repo funding collateralized by securities. Its prime brokerage clients' assets are also at risk of being frozen. In a failure, which mechanism most directly increases the dealer's liquidity drain beyond the loss of unsecured funding?

Clients and counterparties withdrawing excess collateral and demanding higher haircuts or margin most directly adds liquidity drain. As confidence falls, secured lenders and prime brokerage clients pull assets and tighten terms, so the dealer loses funding even though its borrowing is collateralized.

  1. AClients and counterparties withdrawing excess collateral and demanding larger haircuts or marginCorrect
  2. BRegulators lowering risk weights on trading assets
  3. CRise in the dealer's net interest margin
  4. DCentral bank discount window lending at a penalty rate

Explanation

As confidence erodes, repo lenders raise haircuts and clients pull free credit balances and excess collateral, creating cash outflows beyond unsecured funding loss. The other options do not drain liquidity in this way; discount window lending is a source, not a drain.

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