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

A bank's treasury team is deciding why it should run liquidity stress tests in addition to monitoring its regulatory liquidity ratios. Which purpose best reflects the primary objective of a liquidity stress test?

The main purpose of a liquidity stress test is to assess whether a bank can meet its cash obligations under severe but plausible adverse scenarios, and to use the results to set buffers, limits and contingency funding plans, rather than to measure trading losses or capital.

  1. ATo assess whether the bank can meet its cash-flow obligations under adverse but plausible scenarios and to inform contingency planning and limitsCorrect
  2. BTo estimate the bank's 99% one-day loss on its trading book under normal market conditions
  3. CTo determine the minimum regulatory capital required against credit risk exposures
  4. DTo measure the accounting profit expected over the next financial year under baseline assumptions

Explanation

Liquidity stress tests examine whether the bank can survive outflows and funding disruptions under severe but plausible scenarios, and feed into limits, buffers and contingency funding plans. The VaR option describes market risk measurement, the capital option relates to solvency, and the profit option is a baseline forecast, not a stress.

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