Skip to content

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

During the 2007-2009 crisis, many banks funded long-term illiquid assets with short-term wholesale borrowing such as repo and commercial paper. Which outcome most directly illustrates the amplification mechanism created by this funding structure?

The amplification occurred when short-term lenders refused to roll over funding, forcing banks to sell assets at distressed prices. Falling prices cut collateral values and capital, which reduced funding capacity further, creating a self-reinforcing liquidity spiral instead of a stabilizing adjustment.

  1. ALenders refusing to roll over short-term funding forced asset sales at depressed prices, which lowered asset values and further weakened funding capacityCorrect
  2. BHigher deposit insurance coverage raised depositors' confidence and slowed withdrawals from commercial banks
  3. CLonger-term funding reduced refinancing needs and lowered the sensitivity of banks to market shocks
  4. DRising house prices increased collateral values and allowed banks to lower their leverage

Explanation

Reliance on short-term funding exposes a bank to rollover risk. When lenders withdraw, forced sales depress prices, which reduces collateral values and funding capacity, creating a spiral. The other options describe stabilizing effects or conditions inconsistent with the crisis.

Did you get it right without looking?

One question tells you little. A timed set on Anatomy of the Great Financial Crisis of 2007-2009 shows your real accuracy, how long you take and where you lose marks.

Practise Anatomy of the Great Financial Crisis of 2007-2009Free diagnostic mock

More Anatomy of the Great Financial Crisis of 2007-2009 questions