Skip to content

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

A bank's stress test assumes that during a severe scenario its secured funding via repo is rolled over only if collateral haircuts remain unchanged. A reviewer argues this is a weak assumption. Which critique is most valid?

The valid critique is that haircuts and collateral eligibility typically tighten in stress, especially for lower-quality collateral, so the scenario should assume higher haircuts and reduced repo rollover. Holding haircuts constant understates the funding lost and the additional collateral the bank must post.

  1. ARepo funding is never affected by market conditions
  2. BHaircuts and eligible collateral typically tighten in stress, so the scenario should assume higher haircuts and reduced rollover, especially for lower-quality collateralCorrect
  3. CHaircuts only matter for unsecured funding
  4. DCollateral values rise in stress because of flight to quality for all asset types

Explanation

In stress, lenders raise haircuts, narrow eligible collateral and shorten tenors, with greater effect on lower-quality assets. A scenario holding haircuts constant understates funding loss and the extra collateral needed.

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