FRM Exam Part II · Managing Nondeposit Liabilities

Managing Funding Concentration, Cost and Liquidity Risk

Updated 11 October 2026 · Fact-checked

Funding concentration risk is the danger of relying too heavily on one lender, instrument, currency or maturity. You manage it by measuring each source's share of funding, building a maturity ladder to find gaps, pricing funds by cost and stability, setting limits, and keeping a tested contingency funding plan.

Understand Managing Funding Concentration, Cost and Liquidity Risk

A bank funds its assets with deposits and nondeposit liabilities, also called wholesale funding. These include repo, commercial paper, interbank borrowing, secured advances and term debt. Wholesale funds are often cheaper or larger in size than retail deposits. But they are more rate-sensitive and can leave quickly.

Funding concentration risk arises when too much funding depends on one counterparty, one product, one currency, one market or one maturity bucket. If that source closes, the bank must replace it fast, often at a worse price. Concentration also builds a hidden link between funding and collateral: secured funding fails when collateral values or haircuts move.

The second problem is maturity mismatch. A maturity ladder (or liquidity gap table) places expected cash inflows and outflows into time buckets such as overnight, 1 week, 1 month and 3 months. The gap in each bucket is inflows minus outflows. A cumulative negative gap means the bank must raise new funds to survive. Contractual maturities are adjusted with behavioural assumptions, such as rollover rates for each funding type under stress.

Third, funding has a cost. Short-term wholesale funds look cheap but carry rollover risk. Longer-term funds cost more but are more stable. A sound bank prices this difference, for example through liquidity transfer pricing, so business lines pay for the liquidity they use.

Finally, a contingency funding plan (CFP) sets out what the bank does when normal funding fails. It has early warning indicators, escalation triggers, named roles, a list of contingent sources (asset sales, central bank facilities, unused secured lines) and communication steps. Diversification, ladders, pricing and the CFP work together. None replaces the others.

Key formulas to remember

Funding concentration share: Share of source i = Funding from source i ÷ Total funding; Compare against internal limits. Track top lenders, instruments, currencies and maturities separately.
Herfindahl-Hirschman Index (HHI) of funding: HHI = Σ (share_i)²; Shares as decimals. Higher HHI means more concentration. Equal shares across n sources give 1 ÷ n.
Net liquidity gap: Gap in bucket = Cash inflows − Cash outflows; Negative means a shortfall in that bucket.
Cumulative gap: Cumulative gap at bucket t = Σ gaps from first bucket to t; Survival depends on the cumulative figure, not a single bucket.
Stressed outflow: Stressed outflow = Balance × (1 − rollover rate); Use a lower rollover rate for less stable, uninsured or secured-by-weak-collateral funding.
Survival horizon test: Survive if liquid buffer + contingent sources ≥ cumulative net outflow over the horizon; Apply haircuts to buffer assets before comparing.

How to solve Managing Funding Concentration, Cost and Liquidity Risk questions

Use the same sequence for any question on concentration, ladders, pricing or contingency planning.

1Identify the funding sources and their amounts, maturities and collateral needs.
2Compute each source's share of total funding and compare with limits, or compute HHI if asked.
3Apply stress assumptions: rollover rates, haircuts, and inflow restrictions.
4Place stressed inflows and outflows into the maturity buckets and compute gaps, then cumulative gaps.
5Compare cumulative stressed outflow with the liquid buffer after haircuts and with contingent sources to find the survival horizon or shortfall.
6Consider cost: note any shift from cheaper short-term funds to costlier stable funds and how it should be priced.
7State the action: diversify, lengthen maturity, set or tighten limits, or trigger the CFP stage the data points to.

Quickest way: Share, stress, cumulate

When to use it: Use when a question gives a funding table and asks which risk is largest or whether the bank survives.

Convert amounts to shares of total and flag the largest one.
Multiply each balance by (1 − rollover rate) to get stressed outflows.
Add outflows cumulatively across buckets.
Subtract from the haircut-adjusted buffer.
Pick the option that matches the sign and size of the result.

Common mistakes in Managing Funding Concentration, Cost and Liquidity Risk

Treating a low average cost of funds as proof that funding is sound.
Cheap short-term funds look attractive on a profit basis.
Fix: Judge funding on cost and stability together. Cheap overnight funds carry high rollover risk.
Counting diversification only by number of lenders.
Many names seem to mean spread risk.
Fix: Check instrument, currency, maturity, collateral type and market too. Lenders can all be in one market that closes together.
Using contractual maturities in the ladder under stress.
Contractual dates are easy to read from the table.
Fix: Apply behavioural and stress assumptions, such as lower rollover and restricted inflows.
Looking at one bucket's gap instead of the cumulative gap.
A positive later bucket looks reassuring.
Fix: Cumulate from the first bucket. A shortfall must be funded before later inflows arrive.
Ignoring haircuts on buffer assets.
Market value looks like cash.
Fix: Reduce each asset by its haircut before counting it against outflows.
Assuming a CFP is only a document.
Plans are seen as compliance items.
Fix: A CFP needs triggers, owners, tested sources and communication steps. Untested lines may not work in stress.

Worked examples

Example 1

A bank has total funding of USD 10 billion: retail deposits USD 4 billion, repo USD 3 billion, commercial paper USD 2 billion, term debt USD 1 billion. Compute HHI by source and say what it indicates versus four equal sources.

Show the solution

Shares: 0.40, 0.30, 0.20, 0.10.
Squares: 0.16, 0.09, 0.04, 0.01.
HHI = 0.16 + 0.09 + 0.04 + 0.01 = 0.30.
Four equal sources give 1 ÷ 4 = 0.25.
0.30 is above 0.25, so funding is more concentrated than an equal split.

Answer: HHI = 0.30, higher than the 0.25 of equal shares. Funding is moderately concentrated, with retail deposits at 40%.

Example 2

A bank holds a liquid buffer of USD 900 million after haircuts. Stressed net outflows are USD 400 million in the first week, USD 300 million in weeks 2 to 4 combined, and USD 350 million in month 2. Contingent central bank capacity is USD 0 for this test. Does the bank survive two months?

Show the solution

Cumulative after week 1: 400.
Cumulative after month 1: 400 + 300 = 700.
Cumulative after month 2: 700 + 350 = 1,050.
Buffer is 900, so buffer − outflow after month 1 = 900 − 700 = 200 (positive).
After month 2: 900 − 1,050 = −150 (shortfall).

Answer: The bank survives one month with USD 200 million left but has a USD 150 million shortfall by the end of month 2. Its survival horizon is between one and two months. It needs more stable funding or contingent sources.

Exam tips

Read whether the question asks about concentration, maturity mismatch or cost. The best answer usually targets that exact risk.
Expect stress inputs such as rollover rates and haircuts. Apply them before building the ladder.
When options include 'raise cheap short-term funding', treat it as usually wrong for a liquidity problem.
For CFP questions, look for early warning indicators, triggers and tested contingent sources.
Use the cumulative gap, and check the sign before choosing.

Practice questions from Managing Nondeposit Liabilities

Managing Funding Concentration, Cost and Liquidity Risk: frequently asked questions

What is funding concentration risk?

It is the risk of relying too much on one lender, instrument, currency, market or maturity for funding. If that source stops, the bank must replace it quickly and at higher cost. Limits and diversification reduce it.

How does a maturity ladder show funding risk?

It sorts expected inflows and outflows into time buckets and shows the gap in each. A negative cumulative gap means the bank needs new funds. Stress assumptions make the ladder more realistic.

What should a contingency funding plan include?

It should include early warning indicators, escalation triggers, clear roles, a list of contingent funding sources and communication steps. It should also be tested regularly. Sources must be usable under stress.

Why not fund mostly with cheap short-term wholesale money?

It must be rolled over often, and lenders can withdraw fast in stress. The bank then faces rollover risk and may pay far more. Longer, stable funding costs more but lowers that risk.