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

According to the Duffie analysis of dealer bank failure mechanics, which feature of a dealer bank's funding most directly makes it vulnerable to a rapid run by short-term creditors?

Dealer banks depend on short-term secured and unsecured funding that must be rolled over frequently. When confidence falls, creditors can simply decline to roll, causing a fast liquidity drain. Insured deposits, long-term debt and strong equity make runs less likely.

  1. AHeavy reliance on short-term secured and unsecured funding that must be rolled over frequentlyCorrect
  2. BA large base of insured retail deposits
  3. CLong-dated subordinated debt with staggered maturities
  4. DA high proportion of Tier 1 common equity

Explanation

Dealer banks fund inventories of securities largely with short-term repo and commercial paper, which must be rolled over often. If creditors lose confidence they can refuse to roll, draining liquidity quickly. Insured deposits, long-dated debt and high equity all reduce run risk.

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