Skip to content

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

Before its bankruptcy, Lehman Brothers tried to reassure markets by reporting a large liquidity pool. Which weakness, highlighted in analyses of dealer bank failures, most undermined the reliability of that reported pool?

The key weakness was encumbrance. Some assets in the reported pool were already pledged to clearing banks and counterparties, so they could not be freely sold or repoed to meet new outflows, which made the headline liquidity figure overstate true usable liquidity.

  1. APart of the pool was encumbered or pledged to counterparties and clearing banks, so it was not freely available to meet new outflowsCorrect
  2. BThe pool consisted entirely of central bank reserves that were frozen
  3. CThe pool was recorded at below market value under IFRS rules
  4. DThe pool was held only in foreign currencies

Explanation

Collateral posted to clearing banks and other counterparties was not available to meet new needs, so the headline pool overstated usable liquidity. The other options are not the issue identified in the case.

Did you get it right without looking?

One question tells you little. A timed set on The Failure Mechanics of Dealer Banks shows your real accuracy, how long you take and where you lose marks.

Practise The Failure Mechanics of Dealer BanksFree diagnostic mock

More The Failure Mechanics of Dealer Banks questions