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FRM Part II · FRM Exam Part II · Monitoring Liquidity

A bank's treasury team is designing a liquidity stress testing program. Which design choice best reflects sound practice for the scenarios it should run?

Sound liquidity stress testing uses idiosyncratic, market-wide and combined scenarios over multiple time horizons. Each captures a different funding channel and speed of stress. Relying on one scenario, one horizon, or only past history leaves gaps, and capital does not replace liquidity.

  1. ARun only a single market-wide stress, since idiosyncratic events are captured by it
  2. BRun a combination of idiosyncratic, market-wide and combined scenarios over multiple time horizonsCorrect
  3. CRun only a severe overnight scenario, since longer horizons are covered by capital buffers
  4. DUse only historical scenarios drawn from the bank's own past experience

Explanation

Sound practice calls for idiosyncratic, market-wide and combined scenarios across several horizons because liquidity risk can emerge in different ways and speeds. A single scenario misses distinct channels, and relying only on own history ignores plausible but unseen events. Capital does not substitute for liquidity.

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