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FRM Part II · FRM Exam Part II · Contingency Funding Planning

During the 2007-2009 crisis, many dealer banks and conduit sponsors suffered sudden funding strain when off-balance-sheet vehicles could no longer roll their short-term paper. Which contingency funding planning lesson does this best illustrate?

The episode shows that contingent exposures, such as liquidity backstops and reputational support for off-balance-sheet vehicles, can return to the bank during stress. Contingency funding plans must include these in stress cash-flow projections, because legal separation did not stop the funding demands.

  1. AContingent liquidity exposures from off-balance-sheet commitments and reputational support must be included in stress cash-flow projectionsCorrect
  2. BOff-balance-sheet vehicles reduce funding risk because the assets are legally separate
  3. CSecured funding is always more stable than unsecured funding, regardless of collateral quality
  4. DRetail deposits are the main source of outflow in a wholesale funding stress

Explanation

Sponsors often provided liquidity backstops or supported vehicles for reputational reasons, so assets returned to the balance sheet and drew on liquidity. A CFP must therefore capture such contingent claims. Legal separation did not prevent the strain, so the claim that these vehicles reduce funding risk is wrong.

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