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

A bank's stress test shows a survival horizon of 60 days under a market-wide scenario but only 21 days under an idiosyncratic scenario. The risk committee asks how this should inform the contingency funding plan. Which conclusion is most appropriate?

The CFP should be built around the shorter 21-day horizon from the idiosyncratic scenario, because that is where the bank runs out of liquidity first. Averaging the horizons or relying on the milder market-wide result would hide the binding vulnerability and leave actions too slow to execute.

  1. ASet the CFP to the longer horizon since it is more probable
  2. BAverage the two horizons to 40.5 days and design the CFP around that
  3. CIgnore the idiosyncratic result because market-wide scenarios are broader
  4. DDesign the CFP and liquidity buffer around the shorter horizon, since the idiosyncratic scenario is the binding constraint, and plan actions that work within 21 daysCorrect

Explanation

The binding constraint is the scenario producing the shortest horizon because the bank would face a shortfall first. Averaging hides the vulnerability, and breadth of a scenario does not make an idiosyncratic shock less relevant; confidence loss is often quicker and harsher. Actions must be executable well within 21 days.

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