All other things being equal, if a bank borrows short and lends long what is the effect on the liquidity risk of the bank?
A) positive
B) changes only when interest rates levels are high
C) negative
D) changes only when interest rates levels are low

Question

Quizplus · Accepted Answer

Borrowing short and lending long increases the maturity gap, which increases the liquidity risk. If depositors or lenders suddenly demand their funds back, the bank may have difficulty liquidating their long-term loans quickly to meet these demands, potentially leading to default or insolvency. Therefore, the effect is negative.

All Other Things Being Equal, If a Bank Borrows Short