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FRM Part I · FRM Exam Part I · Anatomy of the Great Financial Crisis of 2007-2009

Before the 2007-2009 crisis, a large part of the 'shadow banking' system funded long-term, illiquid assets such as securitized loans mainly by borrowing in which way?

Shadow banking entities financed long-term, illiquid securitized assets mostly with short-term wholesale funding such as asset-backed commercial paper and repo. This maturity mismatch left them vulnerable to runs when investors stopped rolling over funding, unlike traditional banks, which had insured deposits and access to central bank liquidity.

  1. AIssuing long-term subordinated debt with maturities beyond ten years
  2. BShort-term wholesale funding such as asset-backed commercial paper and repurchase agreementsCorrect
  3. CInsured retail deposits protected by government guarantees
  4. DIssuing common equity in public markets at regular intervals

Explanation

Shadow banking vehicles such as conduits, SIVs and broker-dealers relied on short-term wholesale funding (ABCP, repo) to finance long-dated assets. This created a maturity mismatch that exposed them to runs when lenders refused to roll over. Insured deposits were the funding of traditional banks, not of these entities.

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