Certified Financial Management Specialist Practice Exam

What does maturity transformation in banking refer to?

1. The conversion of long-term loans into short-term deposits

2. The conversion of short-term deposits into long-term loans

3. The assessment of loan durations

4. The management of maturity risk

The correct answer is: The conversion of short-term deposits into long-term loans

Maturity transformation in banking primarily refers to the process where financial institutions, such as banks, take in short-term deposits and convert them into long-term loans. This practice is fundamental to how banks operate and enables them to meet the differing time preferences of savers and borrowers. Depositors generally prefer liquidity and may want access to their funds quickly, opting for short-term deposits. In contrast, borrowers often seek long-term financing for purposes such as buying a home or investing in business expansion. The ability of banks to provide long-term loans while managing short-term deposits helps facilitate economic growth and ensures that funds are allocated efficiently across different time horizons. This transformation also means that banks must carefully manage the risks associated with this practice, particularly through interest rate risk and liquidity risk, ensuring that they can meet the demands of depositors while providing stable funding for borrowers over longer periods.