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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 of a dealer bank's funding most directly makes it vulnerable to a rapid run by creditors when confidence falls?

Dealer banks are fragile mainly because they rely on short-term wholesale funding, especially repo and commercial paper, which creditors can refuse to roll over almost at once. A loss of confidence therefore triggers a rapid run, unlike with long-term debt, insured deposits or equity.

  1. AHeavy reliance on long-term subordinated debt with maturities beyond ten years
  2. BReliance on short-term secured and unsecured wholesale funding that creditors can decline to roll overCorrect
  3. CA large base of insured retail deposits
  4. DFunding mainly from common equity issuance

Explanation

Dealer banks fund large inventories of securities with short-term repo and other wholesale funding. Creditors can refuse to roll this funding almost immediately, so a loss of confidence produces a fast run. Long-term debt, insured deposits and equity are stable sources and do not create this run vulnerability.

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