A major cause of the current global financial crisis has been maturity mismatch – too much short-term borrowing in order to finance longterm bank loans. There were serious fundamental problems as well: rapid credit growth and a deterioration in standards of loan assessment, resulting in banks holding many low-quality assets. But these fundamental problems do not explain the depth of the current crisis, which has been greatly amplified by investor panic and withdrawal of these short-term funds.

This chapter is an overview of this argument. Banks have relied on mortgage and other loan-backed securities to finance their loanportfolios, either by selling these securities outright or using them as collateral for short-term borrowing. Other banks have acted as wholesale intermediaries, purchasing the new instruments for trading or investment and financing these holdings using short-term borrowing. Relatively few of these securities were sold to long-term investors.

This short-term wholesale borrowing successfully underpinned the credit boom, until rising losses on US sub-prime lending undermined confidence in the mortgage-backed and other structured securities that were used as collateral for this borrowing. Now banks can no longer ‘rent’ the money they need to lend. Their access to wholesale funding has declined further as the value of the structured credit instruments on bank balance sheets has collapsed, further undermining investor confidence in banks.

Central bank liquidity provision has not solved this problem.