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FRM Part II · FRM Exam Part II · Liquidity Risk

A bank runs a reverse liquidity stress test. Which describes its objective most accurately?

A reverse stress test begins with a failure outcome, such as exhausting the liquidity buffer within the survival horizon, and works backward to identify the shocks and assumptions that would cause it. This exposes hidden vulnerabilities and tests whether risk appetite and limits are suitable.

  1. AEstimate the average liquidity buffer under the base-case budget
  2. BIdentify the scenarios and assumptions severe enough to exhaust the liquidity buffer or break the survival horizonCorrect
  3. CReverse the sign of each cash flow in the maturity ladder to measure inflow sensitivity
  4. DReplicate the regulatory ratio calculation using prior-year data

Explanation

A reverse stress test starts from a defined failure outcome, such as buffer exhaustion before the target horizon, and works backward to find what combination of shocks would cause it. This reveals hidden vulnerabilities and tests whether the risk appetite is appropriate. It is not a base-case estimate or a regulatory ratio recomputation.

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