Short-term funding of long-term assets creates a core tension known as maturity mismatch that can undermine financial stability when liquidity evaporates. Scholars and practitioners have long documented that institutions funding long-duration loans or securities with short-term liabilities become exposed to rollover risk and funding liquidity risk. Gary Gorton of Yale University explains how this structural fragility can produce runs when creditors or counterparties lose confidence, and Darrell Duffie of Stanford Graduate School of Business maps how funding markets transmit stress through repo and wholesale funding channels. In calm markets the transformation supports credit provision; under stress it becomes a vulnerability.
Causes and Mechanisms
Maturity mismatch arises because banks and nonbank financial intermediaries profit by borrowing short and lending long, a practice known as maturity transformation. Reliance on wholesale funding, short-term repos, or uninsured deposits concentrates the risk that creditors will not roll over exposures. Andrew Haldane of the Bank of England has highlighted how market conventions and leverage amplify this risk, while Carmen Reinhart of Harvard University has shown that in many emerging markets foreign currency short-term borrowing compounds sovereign and institutional exposure. Structural features such as asset illiquidity and market concentration make mismatches more dangerous than simple balance sheet numbers imply.
Policy Responses and Stability
Consequences of severe mismatch include forced asset sales, sudden valuation declines, and systemic contagion as fire sales depress prices across institutions. The Basel Committee on Banking Supervision introduced the Liquidity Coverage Ratio and the Net Stable Funding Ratio to limit acute and chronic mismatch respectively, and central banks historically use lender of last resort facilities to backstop short-term funding, a role emphasized in the work of Ben Bernanke of Princeton University. Regulatory minimums and stress testing reduce the probability of rollover failure but cannot eliminate the behavioral and market dynamics that produce runs. Policy design must therefore balance incentives, market functioning, and moral hazard.
Beyond technical safeguards, cultural and territorial differences shape outcomes: regions with less developed local currency markets face higher susceptibility to foreign-funded short-term borrowing, and trust in institutions conditions creditor behavior. Effective mitigation combines robust liquidity regulation, transparent disclosures, credible backstops, and market reforms that reduce the economywide reliance on fragile short-term funding.