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FRM Exam Part II · Contingency Funding Planning

Contingent Funding Sources and Liquidity Buffers

Updated 11 October 2026 · Fact-checked

Contingent funding sources are the emergency liquidity a bank can raise in stress: a liquid asset buffer (HQLA), asset sales, repo and other secured borrowing, and central bank facilities. To answer exam questions, rank sources by speed and reliability, then apply haircuts and limits to find usable liquidity.

Understand Contingent Funding Sources and Liquidity Buffers

A bank's contingency funding plan (CFP) lists where cash will come from when normal funding stops. The sources are not equal. Some are fast and certain. Others are slow, costly or can vanish exactly when you need them.

The core source is the liquid asset buffer: unencumbered, high quality assets that can be sold or pledged quickly with little loss of value. Under Basel III, HQLA are split into Level 1 (cash, central bank reserves, qualifying sovereign debt; no haircut under the LCR) and Level 2 (Level 2A with a 15% haircut, Level 2B with larger haircuts). Level 2 assets are capped in the LCR stock. A buffer must be unencumbered, under the control of the liquidity manager and ideally available in the currency where the outflow occurs.

The next sources are asset sales and secured borrowing. Outright sales give cash but may crystallise losses and signal weakness. Repo and other secured borrowing raise cash against collateral, but the lender applies a haircut, so cash raised = collateral market value × (1 − haircut). In stress, haircuts rise, lenders shorten tenors, and some collateral becomes ineligible. Pledged assets are encumbered and cannot be used twice.

Central bank facilities (for example a discount window or standing lending facility) are the lender of last resort. They accept a wider range of collateral, often with larger haircuts. Limits: access depends on eligible collateral being pre-positioned, there may be stigma if use becomes public, and the facility is meant for solvent banks with temporary problems. Unsecured sources such as interbank lines, commercial paper and new deposits are the least reliable in stress.

Examiners test whether you see the limits. A buffer is only as good as its market liquidity, legal and operational ability to monetise it, currency match, and the stress scenario. Counterbalancing capacity is usable liquidity after haircuts and encumbrance, compared with stressed net outflows over the survival horizon.

Key formulas to remember

Secured borrowing proceeds
Cash raised = Collateral market value × (1 − haircut)
Use the stressed haircut if the question describes stress.
Collateral needed
Collateral required = Cash needed ÷ (1 − haircut)
Rearranged form. Divide by (1 − haircut), do not multiply by (1 + haircut).
Usable buffer
Usable buffer = Σ (market value × (1 − haircut)) for unencumbered eligible assets
Exclude pledged or ineligible assets.
Survival horizon test
Survival horizon is met if counterbalancing capacity ≥ cumulative stressed net cash outflows
Compare capacity with outflows over the chosen horizon.
LCR
LCR = Stock of HQLA ÷ Total net cash outflows over the next 30 calendar days ≥ 100%
Net outflows are stressed outflows less capped inflows.

How to solve Contingent Funding Sources and Liquidity Buffers questions

Use this method for any question on contingent funding sources or liquidity buffers.

  1. 1Identify the stress scenario, time horizon and currency.
  2. 2List every source and mark it unencumbered or encumbered. Drop encumbered assets.
  3. 3Classify each asset by quality (Level 1, 2A, 2B or non-HQLA) and note its haircut.
  4. 4Compute usable value as market value × (1 − haircut). For repo, use the repo haircut; for central bank, use the facility haircut.
  5. 5Apply any caps, such as the Level 2 limits, and any operational limits stated.
  6. 6Total the usable liquidity and compare with stressed net outflows.
  7. 7Interpret: surplus or shortfall, and which source is least reliable.
  8. 8Check the answer options for traps such as double counting pledged assets.

Quickest way: Haircut, sum, compare

When to use it: Numerical MCQs with a list of assets and an outflow figure.

  1. Cross out encumbered or ineligible assets first.
  2. Multiply each remaining asset by (1 − haircut).
  3. Add them and subtract the stressed outflow.
  4. If the question is conceptual, pick the source that is unencumbered, high quality and not dependent on market confidence.

Common mistakes in Contingent Funding Sources and Liquidity Buffers

  • Counting pledged assets in the buffer.

    Candidates add all securities on the balance sheet.

    Fix: Only unencumbered assets count. An asset already used as collateral is gone.

  • Using market value without applying the haircut.

    The haircut is given in a side note.

    Fix: Always compute value × (1 − haircut) before totalling.

  • Treating the central bank as a first source of funds.

    It seems limitless.

    Fix: It is a backstop. It needs eligible, pre-positioned collateral, haircuts apply, and use may carry stigma.

  • Assuming all sources stay available in stress.

    Candidates use normal-market haircuts and tenors.

    Fix: Assume higher haircuts, shorter repo terms and withdrawn unsecured lines.

  • Ignoring currency and location.

    Liquidity is treated as one pool.

    Fix: Check whether assets are in the currency of the outflow and can be moved between entities.

  • Assuming asset sales are costless.

    Candidates use book or mid prices.

    Fix: Allow for fire-sale discounts, market impact and the signalling effect.

Worked examples

Example 1

A bank holds USD 400 million of unencumbered Level 1 assets (0% haircut), USD 200 million of unencumbered Level 2A assets (15% haircut) and USD 100 million of Level 2A assets already pledged. Ignore caps. Stressed net outflows over 30 days are USD 520 million. What is the surplus or shortfall?

Show the solution
  1. Drop the pledged USD 100 million.
  2. Level 1 usable = 400 × (1 − 0) = USD 400 million.
  3. Level 2A usable = 200 × (1 − 0.15) = USD 170 million.
  4. Total usable = 400 + 170 = USD 570 million.
  5. Surplus = 570 − 520 = USD 50 million.

Answer: Surplus of USD 50 million (LCR about 109.6%).

Example 2

A bank needs EUR 85 million cash through repo. The lender applies a 15% haircut on the collateral. How much collateral market value must it pledge, and how much more is needed if stress lifts the haircut to 25%?

Show the solution
  1. Collateral = cash ÷ (1 − haircut).
  2. At 15%: 85 ÷ 0.85 = EUR 100 million.
  3. At 25%: 85 ÷ 0.75 = EUR 113.33 million.
  4. Extra = 113.33 − 100 = EUR 13.33 million.

Answer: EUR 100 million now; EUR 113.33 million in stress, so about EUR 13.33 million more collateral.

Exam tips

  • Read for the word unencumbered. It decides which assets count.
  • Know the Level 1, 2A and 2B haircuts and that Level 2 is capped in the LCR.
  • Conceptual questions reward the answer that notes stress reduces availability of each source.
  • Central bank facility answers usually hinge on collateral eligibility, haircuts and stigma.
  • Check whether the question asks for collateral needed or cash raised; the formulas differ.

Practice questions from Contingency Funding Planning

Contingent Funding Sources and Liquidity Buffers in other exams

The same ground in other exams, if you are preparing for more than one or want another angle on it.

Contingent Funding Sources and Liquidity Buffers: frequently asked questions

What counts as a liquidity buffer?

Unencumbered, high quality liquid assets that can be sold or pledged quickly with little loss. Under Basel III these are Level 1 and Level 2 HQLA, held under the control of the liquidity manager.

How do banks raise liquidity in a crisis?

They use the liquid asset buffer first, then repo and secured borrowing, asset sales, and finally central bank facilities. Unsecured market funding is the least dependable.

Why is a central bank facility not enough on its own?

It requires eligible collateral, applies haircuts, and use can signal weakness. It is intended as a backstop for solvent banks, not a main funding plan.

Does a haircut raise or lower the cash I get?

It lowers it. Cash raised equals collateral value times one minus the haircut, so higher haircuts in stress mean less cash per unit of collateral.