FRM Exam Part II · Liquidity Risk Reporting and Stress Testing

Regulatory Liquidity Stress Testing and Supervisory Expectations

Updated 11 October 2026 · Fact-checked

Regulatory liquidity stress testing checks whether a bank can survive funding stress. The LCR tests a 30-day horizon: HQLA ÷ net cash outflows over 30 days ≥ 100%. The NSFR tests one year: available stable funding ÷ required stable funding ≥ 100%. The Principles for Sound Liquidity Risk Management set supervisory expectations for governance, stress tests and contingency funding.

Understand Regulatory Stress Testing and Supervisory Expectations

A bank turns short-term funding into longer-term assets. That is useful, but it creates liquidity risk. If funding dries up, the bank may be unable to pay on time. Regulators therefore set minimum standards and expect banks to run their own stress tests.

The Liquidity Coverage Ratio (LCR) is a short-term measure. It asks whether the bank holds enough high-quality liquid assets (HQLA) to cover net cash outflows in a 30-day stress scenario. Net outflows are stressed outflows minus stressed inflows, with inflows capped at 75% of outflows. Level 1 assets are the best quality. Level 2 assets get haircuts and are capped in the buffer.

The Net Stable Funding Ratio (NSFR) is a structural, one-year measure. It compares available stable funding (ASF) with required stable funding (RSF). Capital and long-term liabilities have high ASF factors. Stable retail deposits have high factors, and short-term wholesale funding has low ones. Illiquid, long-dated assets need high RSF. The aim is to limit reliance on short-term wholesale funding.

The Principles for Sound Liquidity Risk Management and Supervision (BCBS, 2008) cover several areas. They expect the board to set the liquidity risk tolerance. Senior management must run a strategy and policies. The bank must measure and monitor funding, including across currencies and legal entities. It must run stress tests, keep a contingency funding plan (CFP), hold a liquidity buffer and disclose publicly. Supervisors must assess these and act when they fall short.

The LCR and NSFR are minimum standards. They do not replace internal stress tests. Supervisors expect banks to design their own scenarios, including idiosyncratic, market-wide and combined ones, and to use results in limits, buffers and the CFP.

Key formulas to remember

Liquidity Coverage Ratio: LCR = Stock of HQLA ÷ Total net cash outflows over next 30 days ≥ 100%; Stress scenario of 30 calendar days. HQLA must be unencumbered and liquid in stress.
Net cash outflows (LCR): Net outflows = Total expected outflows − MIN(Total expected inflows, 75% × Total expected outflows); Inflows are capped, so net outflows are at least 25% of gross outflows.
Net Stable Funding Ratio: NSFR = Available stable funding ÷ Required stable funding ≥ 100%; One-year horizon. Each item is weighted by an ASF or RSF factor.
ASF and RSF: ASF = Σ (liability or capital × ASF factor); RSF = Σ (asset or off-balance-sheet item × RSF factor); Higher ASF factor means more stable. Higher RSF factor means less liquid or longer-dated.
Horizon comparison: LCR: 30 days, short-term resilience. NSFR: 1 year, structural funding; A frequent exam contrast.

How to solve Regulatory Stress Testing and Supervisory Expectations questions

Use this method for numerical and conceptual questions on regulatory liquidity standards and stress testing.

1Identify the standard being asked about: LCR, NSFR, a monitoring tool, or the Principles for Sound Liquidity Risk Management.
2Note the horizon: 30 days for LCR, one year for NSFR.
3For LCR, compute gross outflows and inflows, cap inflows at 75% of outflows, then find net outflows.
4Check which assets qualify as HQLA, and use only the eligible, unencumbered amount after any haircuts.
5For NSFR, multiply each item by its ASF or RSF factor, sum each side and divide ASF by RSF.
6Compare the ratio with 100% and state whether the bank complies, and by how much.
7Link to supervisory expectations: stress tests, CFP, governance and disclosure, and say which principle applies.
8Check the answer options for traps such as wrong horizon, uncapped inflows or mixing up ASF and RSF.

Quickest way: Fast ratio check

When to use it: Use when the question gives numbers and asks for a ratio, a shortfall or compliance.

Write the formula and the horizon first.
For LCR, find 75% of outflows and compare it with inflows. Use the smaller figure.
Net outflows = outflows − the smaller figure.
Divide HQLA by net outflows. For NSFR, divide total ASF by total RSF.
Compare with 100% and compute any shortfall as required minus actual.

Common mistakes in Regulatory Stress Testing and Supervisory Expectations

Mixing up the horizons of LCR and NSFR
Both are Basel III liquidity ratios with a 100% minimum.
Fix: Remember LCR is 30 days (short-term resilience) and NSFR is one year (structural funding).
Not capping inflows at 75% of outflows in the LCR
Students subtract all inflows from outflows.
Fix: Always compute net outflows = outflows − MIN(inflows, 75% of outflows).
Counting encumbered or ineligible assets as HQLA
Students treat any liquid-looking asset as HQLA.
Fix: Only unencumbered assets meeting HQLA criteria count, with haircuts and caps on Level 2 assets.
Dividing RSF by ASF in the NSFR
The two terms look alike and the order is easy to reverse.
Fix: NSFR = ASF ÷ RSF. Available is the numerator.
Assuming meeting LCR and NSFR removes the need for internal stress tests
Students see the ratios as a complete solution.
Fix: They are minimum standards. The Principles expect bank-specific stress tests, a CFP and buffers sized to the bank's own risks.
Treating the ratio as a pass only at exactly 100%
Students ignore that the requirement is a minimum.
Fix: The requirement is at least 100%, so 100% complies. Below it is a breach.

Worked examples

Example 1

A bank has HQLA of $9.0 billion. Over the next 30 days under stress, expected outflows are $14.0 billion and expected inflows are $6.0 billion. What is the LCR, and does the bank meet the 100% minimum?

Show the solution

Cap on inflows = 75% × 14.0 = $10.5 billion.
Inflows of $6.0 billion are below the cap, so all $6.0 billion count.
Net outflows = 14.0 − 6.0 = $8.0 billion.
LCR = 9.0 ÷ 8.0 = 1.125, or 112.5%.
112.5% is above 100%.

Answer: LCR = 112.5%. The bank meets the minimum, with a $1.0 billion surplus of HQLA.

Example 2

A bank has available stable funding of €120 billion and required stable funding of €150 billion. Its LCR is 130%. A manager says the bank is fully compliant because its LCR is above 100%. Evaluate.

Show the solution

NSFR = ASF ÷ RSF = 120 ÷ 150 = 0.80, or 80%.
80% is below the 100% minimum.
The LCR measures 30-day resilience. The NSFR measures one-year structural funding.
Passing one does not satisfy the other.
The shortfall in stable funding is 150 − 120 = €30 billion.

Answer: The manager is wrong. The NSFR is 80%, a €30 billion shortfall in stable funding, even though the LCR is 130%.

Exam tips

Know the headline contrast: LCR is 30 days and HQLA-based; NSFR is one year and funding-structure-based.
Always apply the 75% inflow cap before computing LCR. Exam options often include the uncapped answer.
For Principles questions, link each principle to who is responsible: board, senior management or supervisors.
Expect scenario questions asking what a supervisor would expect, such as stress tests of different severities, a CFP and currency-level monitoring.
When both ratios are given, check each against 100% separately.

Practice questions from Liquidity Risk Reporting and Stress Testing

Regulatory Stress Testing and Supervisory Expectations: frequently asked questions

What is the main difference between LCR and NSFR?

The LCR tests whether HQLA covers net cash outflows over 30 days of stress. The NSFR tests whether stable funding covers the liquidity profile of assets over one year. One is short-term resilience and the other is structural funding.

What do the Principles for Sound Liquidity Risk Management require?

They set expectations for governance, risk tolerance, measurement, funding diversification, stress testing, a contingency funding plan, a liquidity buffer and public disclosure. They also set duties for supervisors. They apply to all banks, not just large ones.

Are stress tests required if a bank meets LCR and NSFR?

Yes. The ratios are minimum standards with prescribed assumptions. Supervisors expect banks to run their own stress tests with bank-specific scenarios and to use the results in buffers, limits and the CFP.

Why are LCR inflows capped?

The cap stops a bank relying wholly on inflows during stress. Net outflows are therefore at least 25% of gross outflows, so the bank must hold some HQLA regardless of expected inflows.