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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 tri-party repo most directly makes a dealer bank vulnerable to a rapid funding run when lenders lose confidence?

The key vulnerability is that repo is short-term, often overnight, so lenders can refuse to roll it when confidence falls. The dealer must then quickly find new funding or sell assets, which can trigger a run. Repo is secured, and lenders have no obligation to roll.

  1. ARepo lenders can decline to roll overnight loans, forcing the dealer to replace the funding or sell assets quicklyCorrect
  2. BRepo loans are unsecured, so lenders have no claim on collateral if the dealer defaults
  3. CRepo rates are fixed for one year, preventing the dealer from repricing funding
  4. DRepo lenders are legally required to roll maturing loans to avoid fire sales

Explanation

Much repo funding is overnight or very short term, so lenders can simply refuse to roll it. The dealer must then find replacement funding or sell assets. Repo is secured, not unsecured, and lenders are not obliged to roll.

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