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

Which statement best describes why a dealer bank's reliance on secured funding (repo) does not fully protect it from a run?

Repo is secured, but lenders can protect themselves by raising haircuts, refusing less liquid collateral or shortening maturities. The dealer then must quickly find replacement funding or sell assets, so secured funding still exposes it to a run.

  1. ASecured lenders cannot sell collateral after a default
  2. BRepo lenders can raise haircuts, stop lending against less liquid collateral, or reduce tenor, so the dealer must replace funding quicklyCorrect
  3. CRepo is always long term, so rollover risk is absent
  4. DRepo lenders are prohibited from seizing collateral under bankruptcy law

Explanation

Secured lenders protect themselves by tightening terms rather than staying put: higher haircuts, narrower eligible collateral and shorter maturities. This forces the dealer to find replacement funding or sell assets quickly. Secured lenders generally can liquidate collateral, and repo is typically very short term.

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