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FRM Part II · FRM Exam Part II · Liquidity Risk Management

A mid-sized bank's treasurer reviews the funding profile and finds that 70% of wholesale funding is overnight repo secured by a narrow set of corporate bonds. Which crisis lesson does this profile most directly illustrate as a vulnerability?

Heavy dependence on overnight repo against a narrow collateral set is vulnerable because lenders can raise haircuts or stop accepting the collateral, causing sudden loss of funding. Collateral does not remove rollover risk, as the 2007-2009 crisis showed.

  1. AReliance on short-term secured funding can fail abruptly when haircuts rise or collateral becomes ineligibleCorrect
  2. BSecured funding is immune to runs because collateral removes all rollover risk
  3. COvernight funding lowers liquidity risk because it can be repriced daily
  4. DConcentration in one funding type improves stability through operational simplicity

Explanation

In 2007-2009, repo lenders raised haircuts and refused less liquid collateral, so borrowers dependent on overnight repo faced sudden funding loss. Collateral reduces credit risk but not rollover risk. The other options misstate this.

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