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

A bank's treasury team is designing a liquidity stress testing program. Which scenario design is most consistent with sound practice for capturing both firm-specific and market-wide vulnerabilities?

The best design uses idiosyncratic, market-wide and combined scenarios across different severities and time horizons. Each type stresses different channels of funding and asset liquidity, so a single scenario, a purely historical set, or reliance on regulatory ratios would leave important vulnerabilities untested.

  1. ARun only an idiosyncratic scenario, because market-wide events are covered by regulatory ratios
  2. BRun idiosyncratic, market-wide, and combined scenarios at several severities and horizonsCorrect
  3. CRun a single combined scenario at the most severe level to reduce reporting burden
  4. DRun only historical scenarios, since hypothetical scenarios cannot be validated

Explanation

Sound practice calls for multiple scenario types (idiosyncratic, market-wide, combined) with varying severity and horizon, because each stresses different funding and asset-liquidity channels. A single scenario or only historical events leave blind spots. Relying on regulatory ratios does not replace internal stress tests.

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