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A fundamental characteristic of banks is a mismatch between their assets and liabilities. Their liabilities, primarily customer deposits, are liquid and can be withdrawn on demand. In contrast, their assets, such as loans, are illiquid. This issue is often described as a 'maturity mismatch,' where long-term assets like mortgages or business loans, which are repaid over many years, are funded by short-term liabilities that must be available for immediate repayment.

Liquidity and Maturity Mismatch of Bank Assets and Liabilities

Liquidity risk is the risk that a bank will be unable to meet its obligations to depositors for withdrawals because it cannot convert its illiquid assets, like loans, into cash quickly enough. This is a second major risk for banks, alongside default risk.

Definition of Liquidity Risk

A commercial bank's primary business involves accepting funds from customers into checking and savings accounts, which can be withdrawn at any time. The bank then uses these funds to provide 30-year home loans to borrowers. Which of the following statements best analyzes the fundamental structural challenge inherent in this business model?

A newly established community bank, 'Cornerstone Bank,' has structured its initial operations as follows:

*   **Funding Source:** The bank has successfully attracted $100 million in customer deposits, primarily in checking and savings accounts that customers can withdraw from at any time.
*   **Use of Funds:** The bank has used these funds to provide $90 million in 15-year loans to local small businesses to help them expand their operations. The remaining $10 million is held as cash.

Based on this information, explain the core structural challenge related to the timing and accessibility of the bank's funds. What is the fundamental mismatch in Cornerstone Bank's model?

Bank Operational Structure Analysis

In the context of a commercial bank's operations, explain what is meant by a 'maturity mismatch' between its assets and liabilities.

Explaining the Bank's Maturity Mismatch

A commercial bank's financial stability is enhanced by the fact that its primary assets, such as long-term business loans, have a longer duration than its primary liabilities, such as customer checking accounts.

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