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

Which policy reform most directly addresses the concern that a failing dealer bank's tri-party repo investors will withdraw funding en masse and dump collateral?

Reforms such as minimum or less procyclical haircuts and reduced reliance on clearing banks' intraday credit directly address runs by tri-party repo investors and collateral dumping. Greater rehypothecation or lower capital would worsen fragility, and mandatory court approval of terminations is not the standard reform.

  1. ARaising haircuts on repo collateral through time-varying or procyclicality-limiting minimum haircuts, and reducing reliance on intraday credit from clearing banksCorrect
  2. BAllowing dealers to rehypothecate more client assets
  3. CRemoving the requirement for dealers to hold capital against trading assets
  4. DPermitting repo lenders to terminate only after a court order in all cases

Explanation

Reforms focus on reducing dependence on short-term repo funding and intraday credit from clearing banks, and on haircut floors that limit procyclicality. More rehypothecation or lower capital increases fragility. Court-ordered termination is not the reform discussed and would not fit existing safe harbors.

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