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

Which policy tool most directly addresses the run risk in the tri-party repo market highlighted after the 2008 crisis, in which clearing banks' daily unwind of repo exposed them to dealer default?

Reducing the intraday credit that clearing banks extend to dealers, by changing the daily unwind of tri-party repo, targets the run channel. It limits clearing bank exposure to a dealer default and lowers the risk that the market freezes.

  1. AAllowing dealers to shorten repo maturities to overnight only
  2. BReducing intraday credit extended by clearing banks to dealers by changing the daily unwind of tri-party repoCorrect
  3. CEliminating all haircuts on repo collateral
  4. DRequiring prime brokers to rehypothecate more client assets

Explanation

The daily unwind meant clearing banks financed dealers intraday, concentrating risk. Reforms reduced that intraday credit exposure. Shortening maturities or eliminating haircuts would raise run risk, and more rehypothecation increases fragility.

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