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

During the 2007-2009 crisis, several institutions funded long-term assets with overnight wholesale borrowing. Which lesson about funding sources is best supported by this experience?

The crisis showed that heavy reliance on short-term wholesale funding exposes a firm to rollover risk. When confidence drops, funding can vanish quickly, even for solvent institutions. Secured funding is also vulnerable to rising haircuts, and retail deposits were generally more stable.

  1. AShort-term wholesale funding is cheaper, so its use is justified provided it is rolled over daily
  2. BReliance on short-term wholesale funding creates rollover risk that can materialize abruptly when confidence falls, even for solvent institutionsCorrect
  3. CSecured funding is always immune to withdrawal because collateral eliminates liquidity risk
  4. DRetail deposits are inherently less stable than wholesale funding in a crisis

Explanation

Short-term wholesale funding can disappear quickly when counterparties lose confidence, producing a funding gap even for solvent firms. Secured funding is not immune, since haircuts rise and collateral eligibility narrows. Insured retail deposits have generally proved more stable than wholesale funding.

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