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FRM Part II · FRM Exam Part II · Managing Nondeposit Liabilities

A bank has USD 600 million of commercial paper maturing within 30 days, backed by a committed liquidity facility that it wants to use as a backstop. Which treasury practice best reduces the risk that the backstop fails when needed?

The best practice is to test the facility operationally, size it to cover the paper outstanding under stress, and diversify providers. This ensures that when the market closes the backstop can actually be drawn in full and is not exposed to one counterparty's failure.

  1. ADraw the facility only after the paper market has closed, to minimize carrying costs
  2. BTest the facility operationally, ensure it covers the paper outstanding, and diversify the facility providersCorrect
  3. CRely on a single large provider to simplify the relationship
  4. DSize the facility to cover only the expected, not stressed, share of maturing paper

Explanation

A backstop is reliable only if sized for stressed rollover, operationally tested and not concentrated in one counterparty. Waiting to draw, single-provider reliance and sizing to expected needs all leave the bank exposed when stress hits and providers or markets become strained.

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