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

A bank's reserve strategy holds most of its liquid assets in a single sovereign bond issue and keeps all of it with one custodian. Which risk is this strategy most directly exposing the bank to, from the perspective of sound reserve management?

The bank faces concentration risk. Holding the reserve in one bond issue and with one custodian means a single price shock, operational failure or access problem could impair the whole buffer when it is needed. Diversifying across issuers, instruments and custodians reduces this vulnerability.

  1. AConcentration risk that can impair the reserve's availability and value in stressCorrect
  2. BBasis risk between assets and liabilities repricing dates
  3. CYield curve inversion risk on the loan book
  4. DReinvestment risk from short-dated deposits only

Explanation

Concentrating the reserve in one issue and one custodian means a single event, such as a price shock, operational failure or access restriction, could impair the whole buffer. Diversification across issuers, instruments and custodians reduces this. The other options are interest rate issues not specific to this concentration.

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