CMA Final · Risk Management in Banking and Insurance

Liquidity Risk Management: formula sheet

Full chapter guide

Key formulas

Definition of liquidity risk: Liquidity risk = risk of being unable to meet obligations when due, or only at unacceptable cost; Use this wording to open any definition answer.
Funding liquidity risk: Funding liquidity risk = inability to raise cash or refinance liabilities as needed; Concerns the liability side: deposits, borrowings, rollover.
Market liquidity risk: Market liquidity risk = inability to sell or unwind an asset quickly without a significant price loss; Concerns the asset side: market depth and exit price.
Funding gap: Funding gap = cash outflows − cash inflows in a time band; A positive gap means the bank must raise funds in that band.
Framework chain: Board tolerance → Strategy and policy → Limits → Monitoring by ALCO and risk function → Stress tests and CFP → Board reporting; Use this as the skeleton for any descriptive answer on governance.
Mismatch in a time bucket: Gap = Rate or volume of inflows − outflows in the bucket; Cumulative gap = sum of gaps up to that bucket; Limits are usually set on mismatches, often as a percentage of cash outflows in the bucket. Take the exact limit from the question or the bank's policy; do not assume one.
Limit utilisation: Utilisation % = Actual exposure ÷ Limit × 100; A value above 100% is a breach and triggers escalation under the policy.
Core BCBS themes: Tolerance, funding strategy, measurement, intraday and collateral, stress testing, CFP, disclosure, supervision; Group the principles under these themes instead of memorising numbers.
Gap (mismatch) in a bucket: Gap = Inflows − Outflows; Negative gap means a funding shortfall in that bucket.
Cumulative gap: Cumulative gap = running total of gaps from the first bucket up to the bucket considered; Cumulative gaps are monitored alongside the limits on individual buckets.
Mismatch as % of outflows: Mismatch % = (Inflows − Outflows) ÷ Outflows × 100; A negative figure is compared with the limit, for example the 20% limit in each of the first four buckets.
Tolerance limit check: Negative mismatch ÷ Outflows ≤ 20% (in each of Day 1, 2-7, 8-14 and 15-28 days); Applies bucket by bucket to the first four buckets. Apply the limit given in the question; internal limits for longer buckets may differ.
Liquid assets to total assets: Liquid assets ÷ Total assets × 100; Higher means a bigger cushion.
Loan to deposit ratio: Total loans ÷ Total deposits × 100; A high ratio means more reliance on other funds.
Volatile liabilities dependence: (Volatile liabilities − Temporary assets) ÷ (Earning assets − Temporary assets) × 100; Use the definitions given in the question. Lower is safer.
Liquidity Coverage Ratio: LCR = Stock of HQLA ÷ Total net cash outflows over the next 30 days ≥ 100%; Computed after applying haircuts and the caps on Level 2 assets.
Net cash outflows: Net cash outflows = Total expected outflows − Min(Total expected inflows, 75% × Total expected outflows); Inflows are capped at 75% of outflows, so net outflow is at least 25% of outflows.
Expected outflow or inflow: Amount × run-off rate (outflow) or Amount × inflow rate (inflow); Use the rates given in the question. Do not use remembered rates if the question supplies them.
HQLA stock: HQLA = Level 1 + Level 2A × (1 − 15%) + Level 2B × (1 − haircut); Level 2 assets cannot exceed 40% of HQLA; Level 2B cannot exceed 15%. Apply caps when the question gives enough data.
Net Stable Funding Ratio: NSFR = Available Stable Funding ÷ Required Stable Funding ≥ 100%; ASF = Σ (liability or capital × ASF factor). RSF = Σ (asset or off-balance item × RSF factor).
Stressed net cash outflow: Stressed net outflow = Stressed cash outflows − Stressed cash inflows; Compute for each time bucket and each scenario. Apply the scenario's run-off and haircut assumptions first.
Survival check: Surplus or shortfall = Available liquid assets (after haircuts) − Stressed net outflow; A negative figure is a funding gap that the CFP must cover. Haircuts reduce the value of securities before counting them.
Deposit run-off: Stressed outflow on deposits = Deposit balance × Run-off rate; Use higher rates for large and wholesale deposits than for small, stable retail deposits.
Survival period: Survival period = Available liquid assets ÷ Average daily stressed net outflow; Gives the number of days the bank can last without new funding. It is an indicative measure.
CRR requirement: Required cash with RBI = CRR % × NDTL; Cash balance with RBI; earns no interest. The percentage is set by RBI and changes over time, so use the rate given in the question.
SLR requirement: Required liquid assets = SLR % × NDTL; Held by the bank in cash, gold or approved securities that are unencumbered. Securities pledged elsewhere may not count.
Policy corridor (typical structure): SDF rate = Repo rate − 0.25%; MSF rate = Repo rate + 0.25%; This is the framework since 2022. Use the spreads only if the question does not give the rates. MSF rate is the same as the Bank Rate.
Interest cost of overnight borrowing: Cost = Amount × Rate × Days ÷ 365; Use for comparing repo and MSF cost.
Excess or shortfall: Excess/shortfall = Actual held − Required; Compute separately for CRR and SLR.

Quick revision

Liquidity risk is the risk of being unable to meet obligations when due without unacceptable losses.
Funding liquidity is the ability to raise cash; market liquidity is the ability to sell assets without a big price fall.
The board approves the liquidity risk appetite; ALCO manages it day to day.
Gap = rate-sensitive or maturing inflows minus outflows in a time bucket; a negative gap means a funding need.
Cumulative gap adds the bucket gaps over time and shows the total funding pressure.
LCR = stock of high-quality liquid assets ÷ total net cash outflows over the next 30 days.
NSFR = available stable funding ÷ required stable funding, aimed at a one-year horizon.
LCR is a short-term resilience measure; NSFR limits long-term reliance on unstable funding.
Stress tests use scenarios such as a deposit run, a market shock or a rating downgrade.
A contingency funding plan sets triggers, funding sources, roles and communication for a crisis.
Check the current RBI facilities and minimum ratios before the exam, since they can change.

Common mistakes

Treating liquidity risk as the same as insolvency. Fix: Remember a bank can be solvent, with assets above liabilities, and still be illiquid. Liquidity is about timing and cash; solvency is about net worth.
Mixing up funding and market liquidity risk. Fix: Funding is about raising cash (liabilities). Market is about selling assets (asset side). Use the raise or sell test.
Saying ALCO approves the liquidity strategy instead of the board. Fix: Remember that the board approves strategy, policy and tolerance. ALCO implements, monitors and recommends within that.
Listing BCBS principles from memory with wrong counts or numbers. Fix: Learn the themes (tolerance, funding, measurement, stress tests, CFP, disclosure, supervision) and describe them in your own words.
Dividing the gap by inflows or total assets instead of outflows. Fix: For the mismatch limit, always divide the negative gap by outflows of that bucket.
Placing items by original maturity. Fix: Use residual maturity, the time remaining from the reporting date.
Forgetting the 75% cap on inflows. Fix: Always compute 75% of outflows and use the lower of that and inflows.
Applying no haircut to Level 2 assets. Fix: Only Level 1 counts at full value. Level 2A takes a 15% haircut; use the stated haircut for Level 2B.
Treating stress testing as a forecast of what will happen. Fix: Say it tests resilience under severe but plausible events. It informs buffers and limits.
Listing only bank-specific scenarios. Fix: Always cover bank-specific, market-wide and combined scenarios.

Exam tips

Open every theory answer with a one-line definition, then the two types, then sources. This structure earns marks quickly.
In case-based MCQs, look for the verb: raise, borrow, roll over means funding; sell, unwind, exit price means market.
Use bank examples: deposits, interbank borrowing, loan commitments, government securities.
For 'why do banks face liquidity risk', give maturity transformation first, then three or four other sources.
End longer answers with a short line on management: measuring gaps, buffers, diversified funding and stress tests.
Structure answers by level: board, management, ALCO, risk function, reporting. Examiners reward clear role separation.
In case-based MCQs, look for who is acting beyond their role, or a missing limit, stress test or escalation.
For policy questions, list tolerance, limits, roles, reporting and escalation. Add one line on stress testing and the contingency plan.