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FRM Part II · FRM Exam Part II · Liquidity Risk Reporting and Stress Testing

A bank's reverse stress test for liquidity is being specified. Which description best reflects the purpose and approach of a liquidity reverse stress test?

A liquidity reverse stress test starts from a defined failure outcome, such as exhausting the liquidity buffer within a set horizon, and works backward to identify the events and combinations of shocks that could cause it. This exposes hidden vulnerabilities that forward-looking scenarios may overlook.

  1. AApply regulator-prescribed run-off rates and report the resulting ratio
  2. BStart from the outcome of the bank exhausting its liquidity buffer and identify the combinations of events that would cause itCorrect
  3. CRe-run last year's stress test using prior-year balance sheet data
  4. DReduce all scenario severities until the bank shows a surplus

Explanation

A reverse stress test begins with a defined failure outcome, such as buffer exhaustion within a horizon, and works backward to find plausible scenarios that cause it. This highlights vulnerabilities that forward scenarios may miss. The other options describe ratio reporting, backtesting-like repetition, or manipulating severity.

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