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

A risk analyst at a large dealer bank reviews the firm's balance sheet. Which feature best characterizes the typical dealer bank business model described in Duffie's analysis of dealer bank failure mechanics?

A dealer bank typically holds large securities inventories to make markets and funds them largely with short-term secured borrowing such as repo. This reliance on rolling over short-term funding makes dealers vulnerable to runs by lenders, unlike deposit-funded commercial banks.

  1. AFunding long-term illiquid loans mainly with stable retail deposits
  2. BHolding large inventories of securities financed largely by short-term secured borrowing such as repoCorrect
  3. CHolding mostly cash and government deposits at the central bank financed by equity
  4. DFunding trading assets primarily with long-term subordinated debt and preferred stock

Explanation

Dealer banks make markets by holding securities inventories and finance them heavily in short-term secured markets, notably repo. This creates rollover risk. Retail deposit funding of illiquid loans describes commercial banking, not the dealer model.

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