Module: | MODULE B: RISK MANAGEMENT
Q298: Scenario: Bank Alpha faces a sudden, massive withdrawal of corporate deposits and is unable to meet its clearing house obligations. As a direct result, Bank Beta and Bank Gamma, which have large unsecured interbank lending exposures to Bank Alpha, also face severe liquidity shortages the next morning. Based on banking risk definitions, consider the following statements regarding this scenario:
1. The initial trigger at Bank Alpha represents a catastrophic failure of its funding liquidity risk management.
2. The rapid spread of financial distress from Bank Alpha to Bank Beta and Gamma, is a classic example of contagion or systemic risk.
3. The interbank lending exposures held by Bank Beta and Gamma, must have been completely collateralized to prevent this exact type of market risk.
Which of the statements given above is/are correct?
2. The rapid spread of financial distress from Bank Alpha to Bank Beta and Gamma, is a classic example of contagion or systemic risk.
3. The interbank lending exposures held by Bank Beta and Gamma, must have been completely collateralized to prevent this exact type of market risk.
Which of the statements given above is/are correct?
✅ Correct Answer: A
The correct answer is A. Statement 1 is correct: The sudden inability of Bank Alpha to meet its clearing obligations due to massive deposit withdrawals is the textbook definition of a Funding Liquidity crisis (a bank run). Statement 2 is correct: When the failure or default of one financial institution triggers a domino effect, causing severe distress or default in other interlinked institutions (like Beta and Gamma), this phenomenon is universally defined as Contagion Risk or Systemic Risk.
Statement 3 is incorrect: Firstly, many interbank lending markets (like Call Money) operate on an unsecured basis without collateral.
Secondly, the losses faced by Beta and Gamma due to Alpha's failure represent Counterparty Credit Risk and Liquidity Risk, NOT Market Risk (which deals with price fluctuations of tradable assets).
Statement 3 is incorrect: Firstly, many interbank lending markets (like Call Money) operate on an unsecured basis without collateral.
Secondly, the losses faced by Beta and Gamma due to Alpha's failure represent Counterparty Credit Risk and Liquidity Risk, NOT Market Risk (which deals with price fluctuations of tradable assets).