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

A bank's treasurer is deciding how to hold its liquidity reserve. Which feature best describes a reserve held primarily as a precautionary buffer rather than to meet routine daily settlement needs?

A precautionary liquidity reserve is sized for unexpected stress outflows and held in assets that can be turned into cash quickly with minimal loss of value. It is not for routine settlement, yield maximization, or maturity matching, which would undermine its buffer function.

  1. AIt is sized to cover unexpected outflows under stress and held in assets that can be monetized quickly with limited loss of valueCorrect
  2. BIt is sized to the average daily payment volume and held mainly as operating cash at the central bank
  3. CIt is invested in the highest-yielding loans to maximize net interest margin
  4. DIt is held in long-dated corporate bonds to match the maturity of the bank's longest liabilities

Explanation

A precautionary reserve exists to absorb unexpected stress outflows, so it must be in assets that can be sold or repoed quickly at little discount. Option B describes an operating or transactional balance. Yield maximization and long-dated bonds conflict with the buffer's purpose of immediate liquidity.

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