Explanation:
When a clearing bank cuts off a financial institution's ability to process "daylight overdrafts," the institution becomes completely cut off from payment and settlement systems. Without access to these systems, the bank cannot settle its trades, send out cash, or meet its immediate financial obligations. This results in a terminal and immediate liquidity crisis, forcing the bank to declare bankruptcy. This scenario matches historically significant liquidity risk failures, such as the collapse of Drexel Burnham Lambert.
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Q.50 Molino Bank from Zaragoza, Spain, is experiencing serious problems following the decline in their capital position due to previous trading losses. At some point in time, Molino’s clearing bank starts refusing to process its “daylight overdrafts” transactions. Molino is unable to execute trades or send cash to meet its obligations. What is the result of the situation concerning Molino Bank?
A
A moderate decrease in daily trading.
B
A severe decrease in daily trading.
C
The bank declares bankruptcy.
D
There is no effect on the bank’s business.
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