FRM Exam Part II · Liquidity Risk Reporting and Stress Testing

Survival Horizon and Contingency Funding Plans for FRM Part II

Q: What is a survival horizon in liquidity stress testing?

It is the length of time a bank can meet its stressed net cash outflows using its liquidity buffer and other available counterbalancing capacity. It ends on the first day the buffer is exhausted. Boards often set a minimum horizon in the risk appetite.

Q: What is the difference between a liquidity buffer and a contingency funding plan?

The buffer is the stock of liquid assets that pays outflows. The contingency funding plan is the set of procedures, triggers, roles and funding actions used in a crisis. The CFP also covers sources beyond the buffer, such as secured funding and central bank facilities.

Q: What are examples of early warning indicators for liquidity risk?

Examples include deposit outflows, wider funding or CDS spreads, a share price fall, a rating downgrade, loss of access to a funding market, and rising margin or collateral calls. Each should have a threshold that triggers escalation under the CFP.

Q: How is the liquidity buffer sized from stress tests?

Run the stress scenario over the target horizon and find the peak cumulative net outflow. The usable buffer, after haircuts and exclusions, must be at least that amount. Management often adds a margin for model uncertainty.

Updated 11 October 2026 · Fact-checked

Survival horizon is the number of days a bank can meet its cash outflows under a stress scenario using only its liquidity buffer and other counterbalancing capacity. A contingency funding plan (CFP) sets the early warning triggers, actions, roles and funding sources used when that stress arrives. To solve questions, project stressed net outflows, subtract usable buffer, and find the day cash runs out.

Understand Survival Horizon and Contingency Funding Plans

A liquidity stress test projects cash inflows and outflows under a severe but plausible scenario. The output is not a single number. It is a day-by-day (or bucket-by-bucket) path of cumulative net cash flow. The survival horizon is how long that path stays covered by available liquid resources before the bank cannot pay.

The resources used are the liquidity buffer, also called counterbalancing capacity. These are unencumbered, high-quality assets that can be sold or repoed quickly, plus any reliably available central bank facilities. You must apply haircuts to asset values. You must also exclude assets that are pledged, trapped in another entity or currency, or not monetisable within the horizon. A buffer of ₹100 on the balance sheet may be worth much less in stress.

Supervisors and boards use the survival horizon to set risk appetite. A typical statement is that the bank must survive a combined idiosyncratic and market-wide stress for a minimum period, such as 30 days, with a longer horizon for severe scenarios. The buffer is sized backwards from this: the buffer must cover cumulative stressed net outflows over the required horizon. Reverse stress testing works the other way: it asks what scenario would exhaust the buffer.

Early warning indicators (EWIs) are metrics that signal rising liquidity stress before it hits cash flows. Examples are falling deposit balances, widening own CDS or funding spreads, falling share price, rating downgrade, rising use of secured funding, loss of access to a funding market, and higher margin calls. Each EWI needs a threshold and a trigger level that escalates the issue.

The contingency funding plan turns this into action. It defines stress stages, who sits on the crisis team, which actions come first (for example, repo of liquid securities, then asset sales, then central bank borrowing), how quickly each source can deliver, and how the bank communicates with regulators, markets, depositors and rating agencies. A good CFP is tested, updated and tied to stress test results. Its sources must be realistic: funding that is unreliable in the very stress being modelled should not count.

Key formulas to remember

Net cash flow in a period: Net cash flow(t) = Stressed inflows(t) − Stressed outflows(t); Apply stress run-off and drawdown rates to outflows, and lower roll-over or collection rates to inflows.
Cumulative net cash flow: Cumulative gap(T) = Σ Net cash flow(t), t = 1 to T; A negative value is the funding need that must be covered by the buffer.
Survival horizon: Survival horizon = the first day T at which Buffer + Cumulative net cash flow(T) < 0; The bank survives up to the day before this. If it never turns negative, the horizon exceeds the test period.
Buffer after haircut: Usable buffer = Σ Market value × (1 − haircut), for unencumbered assets only; Exclude encumbered or non-transferable assets.
Required buffer for a target horizon: Required buffer ≥ Maximum cumulative net outflow over the target horizon; Use the peak of the cumulative path, not only the final day.
Simple daily survival estimate: Days survived ≈ Usable buffer ÷ Average daily net stressed outflow; Valid only when outflows are roughly constant; otherwise use the cumulative path.

How to solve Survival Horizon and Contingency Funding Plans questions

Use this order for any question on survival horizon, buffers, EWIs or contingency funding plans.

1Identify the stress scenario: idiosyncratic, market-wide or combined, and its length.
2List stressed outflows and inflows for each period, applying the given run-off, roll-over and drawdown rates.
3Compute net cash flow each period and build the cumulative gap.
4Value the buffer: remove encumbered or non-transferable assets, then apply haircuts.
5Find the first period where buffer plus cumulative net flow turns negative. That sets the survival horizon.
6Compare with the required horizon or limit. State if the bank passes, and size any shortfall.
7For CFP or EWI questions, match the stress stage to its trigger, owner and action, and check that each funding source is realistic under the stress.
8Interpret: say what management or the board should do, such as raise the buffer, lengthen funding or revise triggers.

Quickest way: Cumulative gap against usable buffer

When to use it: Use when the question gives period outflows, inflows and a buffer and asks for survival days or shortfall.

Haircut the buffer first and drop any encumbered assets.
Compute net flow per period and keep a running total.
Add the running total to the buffer and stop at the first negative value.
If asked for the shortfall, take the most negative cumulative gap and subtract the buffer.
For CFP wording questions, pick the option that is stress-tested, has clear triggers and uses sources that stay available in stress.

Common mistakes in Survival Horizon and Contingency Funding Plans

Using the unadjusted market value of the buffer.
The balance sheet figure is easy to read and the haircut is in a later line.
Fix: Always apply haircuts and exclude encumbered assets before any comparison.
Dividing the buffer by the average outflow when outflows are front-loaded.
The shortcut formula is quick and familiar.
Fix: Build the cumulative path. Use the shortcut only when outflows are roughly even.
Counting inflows that will not arrive in stress, such as full roll-over of customer loans or interbank lending.
Candidates assume contractual cash flows hold.
Fix: Use the stress assumptions given. Banks usually keep lending to preserve franchise, so inflows are often reduced.
Treating EWIs as the same thing as stress test outputs.
Both relate to stress and both are monitored.
Fix: EWIs are forward-looking monitoring signals with triggers. Stress tests are scenario projections of cash flows.
Listing central bank borrowing as a first-line source in the CFP.
It looks large and reliable.
Fix: Central bank facilities are usually last resort. Use buffer assets and market sources first, and consider collateral pre-positioning and stigma.
Finding the required buffer from the final-day gap only.
The end point seems like the total need.
Fix: Use the peak cumulative outflow over the horizon, since the gap can be worse mid-period.

Worked examples

Example 1

A bank has unencumbered assets: USD 400 million of government bonds (haircut 5%) and USD 200 million of corporate bonds (haircut 25%). Stressed net cash outflows are USD 120 million per day, constant. How many full days can the bank survive on the buffer alone?

Show the solution

Government bonds usable value = 400 × (1 − 0.05) = 380.
Corporate bonds usable value = 200 × (1 − 0.25) = 150.
Usable buffer = 380 + 150 = USD 530 million.
Cumulative outflow: day 4 = 480, day 5 = 600.
Buffer 530 covers day 4 (530 − 480 = 50 left) but not day 5 (530 − 600 = −70).

Answer: The bank survives 4 full days. The buffer runs out on day 5.

Example 2

A bank must show a 5-day survival horizon. Its usable buffer is EUR 300 million. Stressed net outflows for days 1 to 5 are EUR 90m, 80m, 70m, 50m and 40m. Does it meet the requirement, and what is the headroom or shortfall?

Show the solution

Cumulative outflow day 1 = 90.
Day 2 = 90 + 80 = 170.
Day 3 = 170 + 70 = 240.
Day 4 = 240 + 50 = 290.
Day 5 = 290 + 40 = 330.
Buffer after day 4 = 300 − 290 = 10, still positive.
Buffer after day 5 = 300 − 330 = −30, negative.
The bank survives 4 days, short of the 5-day requirement by EUR 30 million.

Answer: It does not meet the requirement. The shortfall is EUR 30 million, so it needs at least EUR 330 million of usable buffer, or lower outflows, to cover 5 days.

Exam tips

Read whether the buffer figure is before or after haircuts. Many wrong options come from skipping this.
When outflow numbers change by day, build the cumulative path. Do not use a daily average.
For CFP questions, choose answers with clear triggers, named owners, tested actions and realistic funding sources.
Know the role split: stress tests quantify, EWIs warn, the CFP acts, and the buffer pays.
Watch the wording on survival horizon. The answer is the last day covered, not the first day with a shortfall.

Practice questions from Liquidity Risk Reporting and Stress Testing

Survival Horizon and Contingency Funding Plans in other exams

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

CMA FinalStress Testing and Contingency Funding Plan

Survival Horizon and Contingency Funding Plans: frequently asked questions

What is a survival horizon in liquidity stress testing?

It is the length of time a bank can meet its stressed net cash outflows using its liquidity buffer and other available counterbalancing capacity. It ends on the first day the buffer is exhausted. Boards often set a minimum horizon in the risk appetite.

What is the difference between a liquidity buffer and a contingency funding plan?

The buffer is the stock of liquid assets that pays outflows. The contingency funding plan is the set of procedures, triggers, roles and funding actions used in a crisis. The CFP also covers sources beyond the buffer, such as secured funding and central bank facilities.

What are examples of early warning indicators for liquidity risk?

Examples include deposit outflows, wider funding or CDS spreads, a share price fall, a rating downgrade, loss of access to a funding market, and rising margin or collateral calls. Each should have a threshold that triggers escalation under the CFP.

How is the liquidity buffer sized from stress tests?

Run the stress scenario over the target horizon and find the peak cumulative net outflow. The usable buffer, after haircuts and exclusions, must be at least that amount. Management often adds a margin for model uncertainty.