FRM Part II · FRM Exam Part II · Monitoring Liquidity
A bank's treasury prepares a contractual liquidity gap report. Which of the following best describes the main limitation of relying solely on contractual cash flow projections to monitor liquidity?
The main limitation is that contractual projections ignore behavioral and contingent flows, such as deposit runoff, drawdowns of committed lines and prepayments, so actual cash flows can differ materially from legal maturities. Banks therefore supplement them with behavioral and stressed assumptions.
- AThey ignore the maturity dates of assets and liabilities
- BThey do not capture behavioral features such as deposit withdrawals, loan drawdowns and prepayments that differ from contract termsCorrect
- CThey can only be prepared for liabilities, not assets
- DThey overstate funding needs because they assume all counterparties act optimally for the bank
Explanation
Contractual projections place cash flows at legal maturity dates. Actual flows can deviate through behavioral factors such as non-maturity deposit runoff, committed line drawdowns and prepayments. Options A and C are false because contractual reports use maturities for both assets and liabilities, and D mischaracterizes the limitation.
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