FRM Exam Part II · Monitoring Liquidity

Cash Flow Projections and Liquidity Gap Analysis

Updated 11 October 2026 · Fact-checked

A cash flow projection places expected inflows and outflows into time buckets. The gap is inflows minus outflows in each bucket. The cumulative gap adds the gaps up over time. You run it under normal and stressed assumptions. The survival horizon is the first bucket where the cumulative position, after counterbalancing capacity, turns negative.

Understand Cash Flow Projections and Liquidity Gap Analysis

Liquidity risk is the risk that a bank cannot meet payments when they fall due. Profit does not help if cash is short on Tuesday. So treasury teams map cash, not accounting income, over time.

The cash flow ladder (also called a maturity ladder) lists time buckets such as overnight, 2-7 days, 8-30 days, 1-3 months and so on. In each bucket you put contractual inflows (loan repayments, maturing assets) and outflows (maturing deposits, borrowings, derivative payments). The net gap for a bucket is inflows minus outflows. A negative gap means a funding need in that bucket.

The cumulative gap is the running total of net gaps. It shows how large the total funding need becomes as time passes. Limits are usually set on cumulative gaps in short buckets, because short-dated shortfalls are the most dangerous. A maturity mismatch arises when liabilities mature before assets. Some mismatch is normal in banking, so the aim is to measure and limit it, not remove it.

Contractual flows are only a starting point. Under a normal (going-concern) scenario you add behavioural assumptions, such as rolling over most retail deposits and drawing on committed lines at typical rates. Under a stressed scenario you assume deposit runoff, lower rollover of wholesale funding, higher drawdown of credit lines, collateral calls and haircuts on asset sales. Inflows are often cut too, because borrowers may delay payment and assets may not be sold at full value.

Finally you add counterbalancing capacity: the liquid assets and other sources the bank can turn into cash. The survival horizon is how long the bank can meet its outflows under a given stress before this capacity is used up. Regulators and boards use it to judge whether buffers are adequate.

Key formulas to remember

Net gap for a bucket: Net gap(t) = Inflows(t) − Outflows(t); Negative means a net funding need in that bucket.
Cumulative gap: Cumulative gap(T) = Σ Net gap(t), for t = 1 to T; Add buckets in order from the shortest. Do not sum buckets out of sequence.
Cumulative position with buffer: Cumulative position(T) = Opening counterbalancing capacity + Cumulative gap(T); Use the stressed value of the buffer, after haircuts and any assets that are encumbered.
Survival horizon: Survival horizon = last bucket before Cumulative position(T) < 0; Compute under each scenario. A shorter horizon under stress is expected.
Stressed outflow: Stressed outflow = Balance × runoff rate; Runoff rates differ by funding type: stable retail, less stable retail, unsecured wholesale.
Stressed value of a liquid asset: Stressed cash = Market value × (1 − haircut); Apply the haircut before counting an asset as buffer.
Gap limit check: Breach if |Cumulative gap| > limit, for a negative cumulative gap; Limits are often set as a percentage of total assets or as an absolute amount per bucket.

How to solve Cash Flow Projections and Liquidity Gap Analysis questions

Use this order for any ladder, gap or survival horizon question. It keeps stress adjustments and the buffer from being mixed up.

1Read the scenario. Note whether the question asks for contractual, normal behavioural or stressed flows.
2List the time buckets in order, shortest first. Check units and currency.
3Adjust each line for the scenario: apply runoff to liabilities, haircuts and delays to inflows or assets, and drawdowns to commitments.
4Compute the net gap for each bucket as inflows minus outflows.
5Compute the cumulative gap by adding the net gaps in order.
6Add the counterbalancing capacity (after haircuts) to get the cumulative position, if asked for survival horizon or buffer adequacy.
7Find the first bucket where the position or cumulative gap breaches zero or the limit. State the survival horizon as the period before that.
8Interpret in one sentence: what the result means for funding, limits or buffers, and what action follows.

Quickest way: Running-total shortcut

When to use it: Use it when the question gives a small table of buckets and asks which bucket first turns negative or breaches a limit.

Write the net gap for each bucket straight from the table.
Start a running total beside it, beginning with the buffer if one is given.
Stop at the first negative or breached bucket. The survival horizon ends in the bucket before it.
Check that stress factors were applied once and only to the correct lines.
Match your answer to the four options. Reject any that use the wrong sign or skip a bucket.

Common mistakes in Cash Flow Projections and Liquidity Gap Analysis

Treating a cumulative gap as the single-bucket gap
Tables show both columns and the numbers look similar.
Fix: Re-read the column label. Rebuild the running total yourself from the net gaps when unsure.
Counting the full market value of liquid assets as buffer
Students forget that selling or repoing assets in stress costs value.
Fix: Apply the haircut first. Also exclude assets that are already pledged.
Applying stress to outflows but not to inflows
Stress is linked in the mind to depositors leaving only.
Fix: Ask whether each inflow is still reliable. Many stress designs assume reduced or delayed inflows, and the question will say so.
Naming the wrong bucket as the survival horizon
Students give the bucket where the position first turns negative, not the period survived.
Fix: The bank survives up to the bucket before the first negative position. Say which bucket fails and then state the horizon.
Assuming a negative gap is itself a breach of a rule
Maturity transformation always creates negative gaps in some buckets.
Fix: Compare with the stated limit or with buffer coverage. A gap is a problem only if it exceeds limits or cannot be funded.
Mixing contractual and behavioural assumptions
Both appear in the same table and the question wording is skimmed.
Fix: Fix one basis per calculation. Contractual uses legal maturity. Behavioural uses expected rollover or runoff.

Worked examples

Example 1

A bank has these projected net cash flows (USD million) in successive buckets: overnight −20; 2-7 days −35; 8-30 days +10; 1-3 months −60. It holds counterbalancing capacity of USD 70 million after haircuts. In which bucket does the cumulative position first turn negative, and what is the survival horizon?

Show the solution

Cumulative gap after overnight: −20. Position = 70 − 20 = 50.
After 2-7 days: cumulative gap = −20 − 35 = −55. Position = 70 − 55 = 15.
After 8-30 days: cumulative gap = −55 + 10 = −45. Position = 70 − 45 = 25.
After 1-3 months: cumulative gap = −45 − 60 = −105. Position = 70 − 105 = −35.
The position first turns negative in the 1-3 month bucket.

Answer: The position first turns negative (−USD 35 million) in the 1-3 month bucket. The bank survives through the 8-30 day bucket, so the survival horizon is about 30 days.

Example 2

A bank has USD 400 million of unsecured wholesale funding maturing in the next 30 days and USD 600 million of less stable retail deposits. Stress assumes 100% non-rollover of the wholesale funding and 10% runoff of the retail deposits. Contractual loan inflows in 30 days are USD 150 million, and stress assumes only 80% of these are received. It holds USD 300 million of government bonds with a 5% haircut. Find the 30-day stressed net gap and the position after counting the bonds.

Show the solution

Stressed wholesale outflow = 400 × 100% = 400.
Stressed retail outflow = 600 × 10% = 60. Total outflow = 460.
Stressed inflow = 150 × 80% = 120.
Net gap = 120 − 460 = −340.
Stressed bond cash = 300 × (1 − 0.05) = 285.
Position = 285 − 340 = −55.

Answer: The 30-day stressed net gap is −USD 340 million. After the bonds are counted at USD 285 million, the position is −USD 55 million, a shortfall. The bank does not survive 30 days under this stress without other actions.

Exam tips

Check which scenario the question uses before touching any number. Stress and normal flows give different answers from the same table.
Always apply haircuts to the buffer and runoff rates to liabilities, then compute gaps. Many wrong options come from skipping one of these.
For survival horizon, say which bucket fails, then back up one bucket. Options often include both.
Interpretation questions often ask what to do: raise the buffer, term out funding, or tighten the limit on the short buckets.
Watch signs. A negative number is a net outflow. Do not flip it when you add the buffer.

Practice questions from Monitoring Liquidity

Cash Flow Projections and Liquidity Gap Analysis in other exams

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

CMA FinalMeasuring Liquidity: Gap Analysis and Ratios

Cash Flow Projections and Liquidity Gap Analysis: frequently asked questions

What is the difference between a liquidity gap and a cumulative gap?

The liquidity gap is the net of inflows and outflows within one time bucket. The cumulative gap is the running total of those gaps from the shortest bucket onward. Limits and survival horizon use the cumulative figure.

What is the survival horizon in liquidity risk?

It is the length of time a bank can meet its net outflows under a stated stress using its counterbalancing capacity. It ends before the first bucket where the cumulative position turns negative. Boards compare it with a minimum target.

Why do banks use behavioural assumptions in cash flow projections?

Contractual maturity does not show how customers really act. Many retail deposits stay for years, and committed lines may be drawn heavily in stress. Behavioural assumptions give a more realistic view for both normal and stressed cases.

Is a negative cumulative gap always a problem?

No. Banks borrow short and lend long, so negative gaps in some buckets are normal. It becomes a concern when it exceeds a set limit or when the buffer and reliable funding cannot cover it.