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FRM Part II · FRM Exam Part II · The Failure Mechanics of Dealer Banks

Which factor most directly makes a dealer bank's balance sheet vulnerable to a run by its short-term secured lenders when concerns about the dealer's solvency rise?

Dealers rely on short-term secured funding that lenders can refuse to roll over or can reprice through higher haircuts. Because inventories are costly to liquidate quickly, a loss of funding forces fire sales, which accelerates the run and possible failure.

  1. ALenders can refuse to roll over funding, and unwinding positions quickly is costly given inventory illiquidityCorrect
  2. BRegulatory capital requirements that are set too high relative to peers
  3. CDealers hold mainly insured retail deposits that can be withdrawn
  4. DInterest on repo is fixed for ten years so the dealer cannot renegotiate

Explanation

Repo is short-term, so lenders can simply decline to roll over or demand larger haircuts, forcing asset sales at fire-sale prices. Insured retail deposits and ten-year fixed repo do not describe dealer funding.

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