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FRM Part II · FRM Exam Part II · Liquidity Risk

During the 2007-2009 crisis, which feature of the funding structure of many dealer banks and conduits most directly made them vulnerable to a run by short-term creditors?

The key vulnerability was funding long-term, illiquid assets with short-term wholesale liabilities that needed frequent rollover. When creditors lost confidence and refused to roll over or raised haircuts, institutions faced a run and forced asset sales.

  1. AFinancing long-term, illiquid assets with short-term, rollover-dependent liabilitiesCorrect
  2. BFunding mainly with long-term equity
  3. CHolding large amounts of central bank reserves
  4. DMatching asset and liability maturities closely

Explanation

Maturity transformation using short-term wholesale funding such as repo and commercial paper required constant rollover. When confidence fell, creditors refused to roll over or raised haircuts, producing a run. Equity funding, reserves and maturity matching reduce, not increase, this vulnerability.

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