FRM Exam Part II · Liquidity and Reserves Management: Strategies and Policies

Funding Strategies and Diversification for Banks

Updated 11 October 2026 · Fact-checked

Funding strategy is how a bank chooses its mix of funding sources, spreads maturities and caps concentrations so it can pay obligations in stress. You solve questions by identifying the concentration or maturity weakness, measuring it (share of funding, rollover gap), and choosing the fix: more stable, diversified, longer-term funding.

Understand Funding Strategies and Diversification

A bank funds assets with liabilities. Funding liquidity risk is the risk that it cannot raise cash, or roll over debt, when needed, at a reasonable cost. Funding strategy is the set of choices that keeps this risk inside appetite.

There are three levers. The first is the funding mix: retail deposits, corporate and wholesale deposits, interbank borrowing, repo, commercial paper, long-term bonds and central bank facilities. Retail deposits that are insured and tied to a relationship are usually the most stable. Wholesale funding is larger, quicker to arrive and quicker to leave. Unsecured short-term wholesale funding is the first to run in a crisis.

The second lever is the maturity profile. If a bank funds long-dated loans with overnight money, it must refinance every day. A good profile spreads maturities so that only a manageable amount falls due in any week or month. Longer-term funding costs more in normal times. That extra cost is the price of insurance, and good policy accepts it. This idea sits behind the Basel Net Stable Funding Ratio.

The third lever is diversification and concentration limits. Concentration can be by counterparty, product, currency, market, maturity date, or investor type. A bank relying on a few large depositors or one repo market can lose funding at once if they pull out. Policies therefore set limits, for example a maximum share of funding from the top 10 depositors, and report them to the board.

Diversification is not a guarantee. In a systemic stress, many sources dry up together, and secured funding depends on collateral quality and haircuts. So diversification works alongside liquidity buffers, stress tests and a contingency funding plan.

Key formulas to remember

Funding concentration ratio: Concentration = Funding from largest counterparties ÷ Total funding; Compare with the policy limit. Define the group (top 5, top 10) exactly as the question does.
Share of funding source: Share = Funding from source ÷ Total funding × 100%; Use to compare wholesale versus retail reliance.
Loan-to-deposit ratio: LTD = Loans ÷ Customer deposits; A higher ratio means more reliance on non-deposit funding. It is a rough indicator, not a regulatory ratio.
Net Stable Funding Ratio (Basel III): NSFR = Available stable funding ÷ Required stable funding ≥ 100%; Encourages stable, longer-term funding for less liquid assets over a one-year horizon.
Maturity ladder rollover gap: Gap in bucket = Assets maturing in bucket − Liabilities maturing in bucket; A negative gap means refinancing is needed. Cumulate gaps across buckets to see the survival period.

How to solve Funding Strategies and Diversification questions

Use this order for any funding strategy or diversification question.

1Read the balance sheet or scenario and list each funding source with its amount and maturity.
2Classify each source as stable or volatile: insured retail, operational deposits and long-term debt are stable; short-term unsecured wholesale, brokered and uninsured corporate funding are volatile.
3Compute shares and concentration ratios, and compare with any stated limit.
4Build or read the maturity profile and find the buckets where outflows exceed inflows.
5Identify the specific weakness: single counterparty, single market, short tenor, currency mismatch or cliff-edge maturities.
6Choose the response that fixes that weakness directly: add sources, lengthen tenor, set limits, hold buffers.
7Check the link to Basel ratios (LCR, NSFR), stress tests and the contingency funding plan, then pick the answer that matches.

Quickest way: Weakness-first elimination

When to use it: Use for conceptual or case MCQs where you have about two minutes.

Ask: which risk is the stem pointing to: concentration, tenor or source stability?
Cross out options that increase short-term or single-source reliance.
Prefer options that lengthen maturity, spread counterparties or add committed lines.
If numbers appear, compute only the one ratio the stem needs and compare with the limit.

Common mistakes in Funding Strategies and Diversification

Treating all deposits as equally stable.
Deposits look alike on the balance sheet.
Fix: Separate insured retail from uninsured corporate and financial deposits. Stability depends on the depositor type and relationship.
Assuming diversification removes funding risk in a systemic crisis.
Students carry portfolio diversification logic over to funding.
Fix: State that sources can fail together in market-wide stress. Diversification reduces, not removes, risk and must be paired with buffers.
Focusing only on total funding mix and ignoring maturity dates.
Mix is easy to see, while the ladder needs more work.
Fix: Always check how much falls due in the short buckets. A good mix can still have a cliff-edge.
Choosing the cheapest funding as the best strategy.
Cost minimisation sounds sensible.
Fix: Longer, stable funding costs more but lowers rollover risk. Policy trades cost against resilience.
Treating secured funding as risk-free.
Collateral feels like protection.
Fix: Secured funding still depends on collateral quality, haircuts and counterparty willingness to roll. Haircuts rise under stress.
Mixing up the denominator when computing concentration.
Questions may give total liabilities, total funding or wholesale funding.
Fix: Use the denominator named in the question and write it down before dividing.

Worked examples

Example 1

A bank has total funding of $50 billion. Retail insured deposits are $20 billion, corporate deposits $12 billion, repo $10 billion, commercial paper $5 billion and long-term bonds $3 billion. Policy limits short-term wholesale funding (repo plus commercial paper) to 25% of total funding. Is the limit met?

Show the solution

Short-term wholesale funding = 10 + 5 = $15 billion.
Share = 15 ÷ 50 = 30%.
Compare: 30% is above the 25% limit.
The excess is 30% − 25% = 5 percentage points, or $2.5 billion.

Answer: No. Short-term wholesale funding is 30% of total funding, breaching the 25% limit by $2.5 billion.

Example 2

A bank's top five depositors hold €18 billion of its €120 billion total funding. Policy caps the top-five share at 12%. Next month, €6 billion of the top-five deposits is due to be withdrawn and not replaced. What is the concentration ratio now, and after the withdrawal, assuming total funding falls by the same amount?

Show the solution

Current ratio = 18 ÷ 120 = 15%, which exceeds the 12% cap.
After withdrawal, top-five deposits = 18 − 6 = €12 billion.
Total funding = 120 − 6 = €114 billion.
New ratio = 12 ÷ 114 = 10.53%.
10.53% is below the 12% cap.

Answer: The ratio is 15% now (a breach) and about 10.5% after the withdrawal, which is within the cap. Note the fix came from losing funding, not from diversification, so the bank should raise broader-based funding.

Exam tips

Look for the one weakness in the stem, such as a few large depositors or heavy overnight reliance, and pick the answer that targets it.
Write the denominator before computing any ratio, and check units (billions, percentages).
Expect NSFR and LCR links: NSFR is about stable funding over one year, LCR about high-quality liquid assets over 30 days.
Be wary of options saying diversification eliminates risk or that wholesale funding is always worse. Use qualified wording.

Practice questions from Liquidity and Reserves Management: Strategies and Policies

Funding Strategies and Diversification in other exams

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

Funding Strategies and Diversification: frequently asked questions

How do banks manage funding concentration risk?

They set limits by counterparty, product, currency and maturity date, and report them to the board. They also build relationships with many investors and depositors, and keep committed backup lines and liquid buffers.

Why is wholesale funding riskier than retail funding?

Wholesale providers are large, informed and quick to withdraw, so funding can vanish within days. Insured retail deposits are small, dispersed and more sticky. Wholesale funding is not always bad, though, and long-term wholesale debt can be stable.

What is a funding maturity profile?

It is the schedule of when liabilities fall due, shown in time buckets. A sound profile avoids large amounts maturing in the same short window, so the bank is not forced to refinance heavily at once.

Does diversification fully protect a bank's funding?

No. In a market-wide stress many sources can fail together. Diversification lowers the risk of one source failing, and works best with buffers, stress testing and a contingency funding plan.