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

Duffie argues that the failure of a large dealer bank is difficult to manage under ordinary bankruptcy. Which proposed change to the resolution framework is most consistent with his concerns?

A resolution mechanism that keeps critical operations running, provides temporary funding and puts losses on shareholders and creditors fits Duffie's concerns about disorderly dealer failures. Removing liquidity facilities, relying more on overnight repo or banning position transfers would make failure more disorderly.

  1. AEliminating all central bank liquidity facilities for dealers
  2. BCreating an orderly resolution mechanism that can provide temporary funding and keep critical operations running while imposing losses on shareholders and creditorsCorrect
  3. CRequiring dealers to fund entirely with overnight repo
  4. DForbidding any transfer of positions to a third party during resolution

Explanation

An orderly resolution authority can keep the dealer's critical functions running, supply temporary liquidity and impose losses on investors rather than taxpayers. Relying on overnight repo increases run risk, and forbidding transfers prevents orderly wind-down.

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