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FRM Part II · FRM Exam Part II · Structured Credit Risk

During the crisis, many banks that sponsored asset-backed commercial paper conduits and structured investment vehicles (SIVs) ended up absorbing losses onto their own balance sheets. What was the main reason?

Sponsors absorbed losses because liquidity backstops and reputational concerns pushed them to support conduits and SIVs when short-term funding markets froze. The vehicles' maturity mismatch meant the risks returned to the sponsors' balance sheets despite being nominally off-balance-sheet.

  1. AReputational risk and liquidity backstop commitments led sponsors to support off-balance-sheet vehicles when funding markets frozeCorrect
  2. BThe vehicles were legally required to transfer all losses to the sponsor under securities law
  3. CSponsors held all equity tranches of the conduits by regulation
  4. DRating agencies mandated that sponsors repurchase assets after downgrades

Explanation

Conduits and SIVs financed long-term assets with short-term paper, relying on rollover. When markets froze, liquidity facilities were drawn and sponsors supported vehicles to protect their reputations, bringing risks back on balance sheet. The other options invent legal mandates.

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