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

Which policy reform discussed for dealer bank failures is designed to ensure that a failing dealer has enough loss-absorbing resources to be recapitalized without taxpayer support?

Requiring total loss-absorbing capacity in the form of long-term debt that can be written down or converted to equity lets a failing dealer be recapitalized in resolution by its own creditors. This limits the need for taxpayer support and keeps critical functions operating.

  1. ARaising haircut floors on all repo transactions
  2. BRequiring total loss-absorbing capacity of long-term debt that can be written down or converted to equityCorrect
  3. CEnding central bank lender-of-last-resort facilities
  4. DAllowing counterparties unlimited close-out rights

Explanation

Long-term unsecured debt that can be converted or written down in resolution (a bail-in) absorbs losses and recapitalizes the firm, avoiding taxpayer support. Haircut floors address procyclicality, and unlimited close-out rights worsen runs.

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