Explanation:
Northern Rock's business model relied heavily on short-term wholesale funding and securitization to finance its long-term mortgage lending. When wholesale and securitization markets froze in 2007, the bank could not roll over its short-term debt and faced a severe liquidity shortage, which then sparked a run by retail depositors. This case serves as a textbook example of the dangers of over-reliance on short-term wholesale funding and highlights the importance of maintaining a well-diversified funding base.
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Q.52 In 2007, Northern Rock, a UK bank, experienced a severe liquidity crisis that ultimately led to its nationalization. This case highlighted several critical issues in liquidity risk management. Which of the following statements most accurately describes a key lesson from the Northern Rock crisis and its implications for liquidity risk management?
A
The crisis revealed the importance of stress testing liquidity under various scenarios, including prolonged disruptions in securitization markets and potential retail deposit outflows.
B
Northern Rock's crisis demonstrated that retail deposits are the most unstable funding source during market stress, emphasizing the need for banks to rely more heavily on wholesale funding markets.
C
Northern Rock's experience highlighted the risks of over-reliance on short-term wholesale funding and securitization, underscoring the importance of maintaining a balanced and diversified funding structure.
D
The crisis underscored the necessity for banks to maintain high capital buffers as a primary defense against liquidity shortages.
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