Explanation:
Maturity transformation is a fundamental function of banks, where they convert short-term liabilities (like deposits) into long-term assets (like loans). This process allows banks to earn a spread, as long-term interest rates are typically higher than short-term rates. However, this also exposes banks to funding risks, particularly in times of financial stress. If a bank has a large maturity mismatch, meaning its liabilities are much shorter-term than its assets, it may face difficulties in rolling over its short-term liabilities. This could lead to a liquidity crisis if depositors demand their money back and the bank is unable to meet these demands. Therefore, while maturity transformation is a necessary function of banks, excessive maturity mismatch can make banks vulnerable to funding risks.
Choice A is incorrect. While it's true that banks can earn a spread through maturity transformation, this isn't necessarily tied to a negative sloping yield curve. In fact, banks often
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Q.4168 You are a student in a Risk Management class. Your lecturer asks you to explain maturity transformation across banks’ balance sheets. Which of the following is correct about maturity transformation across banks’ balance sheets?
A
A maturity mismatch needed to facilitate long term investment projects should allow banks to earn a spread in a negative sloping yield curve surrounding.
B
Banks do not transfer funds from agents in surplus, demanding short-term deposits to agents in deficit with long-term financing needs.
C
Banks might be motivated to increase their maturity mismatch excessively and thus, making themselves vulnerable to funding risks related to short-term liabilities roll-over.
D
It mitigates upward pressure and interbank rate volatility on the U.S dollar
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