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

A bank's validation team reviews its liquidity stress testing governance. Which finding would be the most serious weakness?

The most serious weakness is management changing scenario assumptions after seeing results to avoid reporting limit breaches, with no documented challenge. This erodes the integrity of stress testing and its role in decisions, whereas regular review, board reporting and combined scenarios are accepted good practice.

  1. AManagement routinely adjusts scenario assumptions after seeing results so that no limit breaches are reported, without documented challengeCorrect
  2. BScenarios are reviewed at least annually and after major market events
  3. CThe results are reported to the asset-liability committee and board
  4. DScenario design includes both idiosyncratic and market-wide shocks

Explanation

Adjusting assumptions after seeing results to avoid breaches, with no documented challenge, undermines the independence and credibility of the testing and defeats its use in decisions. The other items are good practices: regular review, board reporting and combined scenario types.

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