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Answer: If a fractional-reserve bank carries out a liquidity and maturity transformation, and has liabilities it is obligated to repay at par and on demand, a properly calibrated asset liability management system can fully immunize (protect) the fractional-reserve bank against a general loss of confidence in its ability to pay out depositors.
## Explanation Statement D is NOT accurate because: - **Fractional-reserve banking inherently creates vulnerability**: Even with a properly calibrated asset liability management (ALM) system, a fractional-reserve bank cannot be "fully immunized" against a general loss of confidence. - **The nature of fractional reserves**: Banks hold only a fraction of deposits as reserves, meaning they cannot simultaneously pay all depositors if they all demand their funds at once. - **Bank runs are self-fulfilling prophecies**: When depositors lose confidence, they withdraw funds, forcing the bank to liquidate assets at potentially unfavorable prices, which can trigger insolvency. - **ALM limitations**: While ALM can help manage maturity mismatches and liquidity risk, it cannot eliminate the fundamental vulnerability created by fractional reserves and on-demand liabilities. **Why the other statements are correct:** - **A**: Correctly describes funding liquidity risk and maturity mismatch - **B**: Accurately describes the core functions and transformations of commercial banking - **C**: Correctly identifies capital and reserves as mitigants for bank fragility Statement D overstates the protective capabilities of ALM systems in the context of fractional-reserve banking.
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About the funding liquidity risk of a fractional-reserve bank, Malz asserts each of the following statements as true EXCEPT which statement is not accurate?
A
Funding liquidity risk arises for market participants who borrow at short term to finance investments that require a longer time to become profitable; the balance-sheet situation of a market participant funding a longer-term asset with a shorter-term liability is called a maturity mismatch.
B
In theory, the core function of a commercial bank is to take deposits and provide commercial and industrial loans to non-financial firms. In doing so, the bank carries out transformations in liquidity, maturity, and credit; it transforms long-term illiquid assets (e.g., loans to businesses) into short-term liquid ones, including deposits and other liabilities that can be used as money.
C
Bank fragility can be mitigated through higher capital (which reduces depositors' concern about solvency, the typical trigger of a bank run), and higher reserves (which reduces concern about liquidity).
D
If a fractional-reserve bank carries out a liquidity and maturity transformation, and has liabilities it is obligated to repay at par and on demand, a properly calibrated asset liability management system can fully immunize (protect) the fractional-reserve bank against a general loss of confidence in its ability to pay out depositors.