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

According to Duffie's analysis of the failure mechanics of dealer banks, which feature most directly makes a dealer bank more vulnerable to a sudden loss of confidence than a traditional commercial bank funded by insured deposits?

Dealer banks are fragile mainly because they rely on short-term wholesale funding, such as repo and commercial paper, that counterparties can pull or refuse to roll over quickly, unlike insured retail deposits, so a loss of confidence can drain liquidity very fast.

  1. AHeavy reliance on short-term secured and unsecured wholesale funding that counterparties can withdraw quicklyCorrect
  2. BLarge holdings of insured retail deposits that can be withdrawn on demand
  3. CA business model focused on long-term fixed-rate mortgage lending held to maturity
  4. DMandatory use of central bank standing facilities for all daily funding

Explanation

Dealer banks fund large inventories of securities and derivatives positions with short-term wholesale funding such as repo and commercial paper, which runs when counterparties lose confidence. Insured retail deposits are a more stable source, so option B describes a stabilizing feature, not the fragility.

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