Financial Risk Manager Part 1
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During the period preceding the financial crisis of 2007-2008, banks experienced an increase in the maturity mismatch on their balance sheets. This situation, where the maturity of a bank's assets does not align with that of its liabilities, led to a significant problem:
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A
Exposure to massive cash withdrawals at short notice.
B
Exposure to credit default risk.
C
Exposure to funding liquidity risk.
D
Unprecedented legal confrontations with regulatory authorities.
Explanation:
Explanation
Funding liquidity risk is the correct answer because:
- Maturity mismatch occurs when a bank's assets (loans, investments) have longer maturities than its liabilities (deposits, short-term borrowings)
- This creates a situation where the bank may not have sufficient liquid assets to meet its short-term obligations
- During the 2007-2008 financial crisis, banks faced:
- Short-term funding drying up
- Inability to roll over short-term debt
- Difficulty in meeting immediate cash demands
Why other options are incorrect:
- A: While cash withdrawals are related, the core issue is broader funding availability, not just deposit withdrawals
- B: Credit default risk relates to borrowers failing to repay, not the timing mismatch between assets and liabilities
- D: Legal confrontations were a consequence, not the primary problem caused by maturity mismatch
The maturity mismatch problem specifically creates funding liquidity risk because banks need to continuously refinance short-term liabilities while holding longer-term assets that cannot be quickly liquidated.
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