Skip to content

FRM Part II · FRM Exam Part II · Liquidity Stress Testing

A bank runs a severe combined stress scenario in which a credit rating downgrade triggers collateral calls, retail deposit runs, and a freeze in secured funding markets at the same time. Management argues that because each individual shock has been tested separately and passed, the combined scenario is unnecessary. Which response best reflects sound stress testing practice?

Combined scenarios are still needed because liquidity shocks interact and amplify each other, such as a downgrade driving collateral calls while funding markets close. Passing each test alone does not show survival of the joint, second-round effects. Single-factor tests still remain useful as sensitivity analysis alongside combined scenarios.

  1. AAgree, because the combined impact equals the largest single-shock impact
  2. BAgree, because separate tests are additive and already show the bank can survive
  3. CDisagree, because liquidity shocks interact and reinforce each other, so combined scenarios are needed to capture feedback effects and second-round impactsCorrect
  4. DDisagree, because combined scenarios should replace all single-factor tests, which have no value

Explanation

Liquidity risk drivers are correlated and amplify one another, for example a downgrade increases collateral calls while reducing access to secured funding, and asset fire sales depress prices. Combined scenarios capture these interactions. Single-factor tests remain useful for sensitivity analysis, so they should not be replaced entirely, and the combined impact is not simply the maximum or a clean sum of individual shocks.

Did you get it right without looking?

One question tells you little. A timed set on Liquidity Stress Testing shows your real accuracy, how long you take and where you lose marks.

Practise Liquidity Stress TestingFree diagnostic mock

More Liquidity Stress Testing questions