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FRM Part II · FRM Exam Part II · Liquidity and Reserves Management: Strategies and Policies

A bank's buffer is sized to cover a 30-day combined stress. A treasurer proposes cutting the buffer by shifting from central bank reserves to higher-yielding securities that are eligible collateral but trade in thin markets, arguing eligibility ensures liquidity. Which is the strongest risk-management objection?

The strongest objection is that thin-market securities may be sellable only at steep discounts in stress, and eligibility alone may not guarantee timely monetisation, so realisable value could fall below the value assumed when sizing the buffer.

  1. ACentral bank eligibility removes all market-liquidity risk, so the shift has no downside
  2. BUnder stress, thin-market securities may only be sold at large discounts, and eligibility may not cover use in a bank-specific stress, so realisable value may fall short of the buffer's assumed valueCorrect
  3. CHigher-yielding securities always reduce the bank's capital ratio
  4. DSecurities cannot be counted in any buffer because only cash qualifies

Explanation

Buffer value depends on realisable value under stress, including market depth and haircuts, as well as operational ability to monetise. Eligibility does not guarantee rapid conversion at assumed prices. The other options are false generalisations.

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