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FRM Part II · FRM Exam Part II · Contingency Funding Planning

A bank's reverse stress test for liquidity is being reviewed by the risk committee. Which description best characterizes a reverse liquidity stress test?

A reverse liquidity stress test starts from a defined failure point, such as the liquidity buffer being exhausted, and works backward to find the combinations of events and assumptions that could cause it. This helps uncover vulnerabilities that forward scenarios may miss.

  1. AIt re-runs last year's stress scenarios using updated balance sheet data
  2. BIt starts from a defined failure outcome, such as exhausting the liquidity buffer, and works back to identify the events that would cause itCorrect
  3. CIt applies the same outflow rates to every funding source to simplify aggregation
  4. DIt measures the profit impact of a rise in funding spreads over one year

Explanation

A reverse stress test begins with an unacceptable result, such as the buffer being depleted or the survival horizon falling below the limit, and identifies the scenarios and assumptions that lead there. It is different from re-running scenarios, uniform run-off assumptions, or earnings sensitivity analysis.

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