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

A dealer bank's prime brokerage clients hold cash balances and unencumbered securities at the dealer. Rumors about the dealer's solvency circulate. Which behavior best illustrates a source of fragility highlighted in the failure mechanics of dealer banks?

Clients pulling free cash balances, unencumbered securities and excess margin from the dealer is a classic run channel. The dealer often reuses these assets for its own funding, so their withdrawal quickly drains liquidity and can push a stressed dealer toward failure.

  1. AClients increase their cash balances and leave excess margin at the dealer to show support
  2. BClients withdraw free credit balances and unencumbered securities, and demand return of excess margin, draining the dealer's liquidityCorrect
  3. CClients move from bilateral derivatives to central clearing, increasing the dealer's available liquidity
  4. DClients reduce leverage, which raises the dealer's revenue from financing

Explanation

Prime brokerage and derivatives clients can withdraw cash and unencumbered assets quickly, removing funding the dealer may have rehypothecated. This accelerates a run. Option A is the opposite of runaway behavior.

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