How does reliance on purchased liquidity rather than core deposits affect a bank?
I. Increases the risk of a liquidity crisis
II. Allows the bank to adjust to deposit drains without affecting bank size
III. Increases overall interest sensitivity of the bank's profits to interest rates

Question

Quizplus · Accepted Answer

Reliance on purchased liquidity rather than core deposits increases the risk of a liquidity crisis because such sources of funds can be more volatile and less reliable in times of financial stress. It allows the bank to adjust to deposit drains without affecting bank size, as the bank can replace lost deposits with purchased funds. This reliance also increases the overall interest sensitivity of the bank's profits to interest rates, as the cost of purchased liquidity can vary significantly with market interest rates, affecting the bank's net interest margin.

How Does Reliance on Purchased Liquidity Rather Than Core Deposits