Final answer:
It is false that heavy risk exposure due to short-term borrowing can be compensated by holding illiquid assets. Banks must manage asset-liability time mismatches and mitigate risks of loan defaults through diversified strategies, not by holding illiquid assets.
Step-by-step explanation:
The statement that heavy risk exposure due to short-term borrowing can be compensated for by carrying illiquid assets is false. Short-term borrowing brings about a risk due to the asset-liability time mismatch where banks have short-term liabilities and long-term assets. This mismatch implies that while customer deposits (liabilities) can be withdrawn quickly, loans and bonds (assets) will only mature and be repaid over a longer period. This can become problematic, especially if interest rates rise and the bank has to pay higher interest to depositors than what they earn from existing loans.
Banks can mitigate the risk of loan defaults through strategies such as diversifying loans, selling loans in the secondary market, and holding more government bonds or reserves. These strategies provide greater liquidity and financial stability than holding illiquid assets would. In times of economic downturns, banks' net worth might decline due to a higher rate of loan defaults, and holding illiquid assets provides little to no immediate relief in covering short-term obligations.