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FRM Part II · FRM Exam Part II · Liquidity Risk Management

During the 2007-2009 crisis, many institutions that relied heavily on short-term wholesale funding experienced severe liquidity problems. Which feature of that funding most directly explains why the stress spread so quickly?

Short-term wholesale funding has to be rolled over frequently, so when confidence collapsed lenders simply refused to refinance or demanded larger haircuts. This rollover risk caused funding to vanish quickly, unlike stable insured retail deposits.

  1. AShort maturities meant large amounts had to be rolled over frequently, so a loss of confidence caused rapid funding withdrawalCorrect
  2. BWholesale funding is fully insured, which encourages investors to withdraw at the first sign of trouble
  3. CWholesale funding has longer maturities than retail deposits, which locks in high costs
  4. DWholesale investors are typically unaware of the borrower's credit quality

Explanation

Short-term wholesale funding must be refinanced often, creating rollover risk. When confidence fell, lenders declined to roll over or raised haircuts, producing quick funding loss. Wholesale funding is generally uninsured and short, and investors are typically credit sensitive, so the other statements are wrong.

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