Financial Risk Manager Part 1

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.