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

A bank's treasury team runs a reverse liquidity stress test. Which description best matches the approach?

A reverse stress test starts from a defined failure outcome, such as the liquidity buffer running out within a set period, and works backward to identify which scenarios and assumptions could produce it. It does not begin with a prescribed scenario and measure the result.

  1. AApply a standard historical scenario and measure the resulting survival horizon
  2. BStart from a defined failure outcome, such as exhausting the liquidity buffer within a set period, and identify the scenarios and assumptions that could cause itCorrect
  3. CRe-run the prior year's stress test using the same shocks but with a shorter horizon
  4. DReverse the sign of all inflow and outflow assumptions to test the effect of excess liquidity

Explanation

Reverse stress testing begins with an unacceptable outcome, such as the buffer being depleted, and works backward to find the combinations of events that lead to it. The other options start from a given scenario or are not reverse stress tests at all.

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