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FRM Part I · FRM Exam Part I · Anatomy of the Great Financial Crisis of 2007-2009

Which statement best describes the role of short-term wholesale funding, such as repo and asset-backed commercial paper, in the origins of the crisis?

Short-term wholesale funding let institutions finance long-term, illiquid assets with borrowing that had to be rolled over frequently. When confidence collapsed, lenders refused to roll funding or demanded larger haircuts, creating liquidity runs and forced asset sales that amplified the crisis.

  1. AIt gave financial institutions stable, long-term funding that matched their illiquid assets
  2. BIt allowed institutions to fund long-term, illiquid assets with short-term borrowing, creating rollover risk that became acute when confidence fellCorrect
  3. CIt was provided mainly by insured retail depositors, so runs were impossible
  4. DIt was prohibited for investment banks before 2007

Explanation

Institutions and conduits financed long-dated mortgage-related assets with overnight or short-term borrowing. When asset values and counterparty confidence fell, lenders refused to roll over or raised haircuts, forcing fire sales. Wholesale funding was not insured retail deposits.

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