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FRM Part II · FRM Exam Part II · Liquidity and Reserves Management: Strategies and Policies

A regional bank relies on 70% of its wholesale funding from three large money market funds. The treasurer proposes to reduce liquidity risk without changing total funding cost materially. Which action best addresses the concentration risk in the funding strategy?

The best response is to diversify the investor base across counterparties, instruments and markets and to set concentration limits per provider. This lowers the chance that one funding source withdrawing causes a liquidity shortfall, whereas shortening maturities or relying more on the same funds increases concentration and rollover risk.

  1. AExtend the maturity of all funding from the three funds to overnight to retain flexibility
  2. BBroaden the investor base across counterparties, instruments and markets, and set concentration limits by providerCorrect
  3. CIncrease the share of funding from the three funds because strong relationships reduce rollover risk
  4. DHold all additional liquidity in the same currency as the largest funding provider's balance sheet

Explanation

Funding diversification means spreading liabilities across providers, instruments, maturities and markets, supported by concentration limits. Shortening to overnight raises rollover risk, and deepening reliance on three providers increases concentration rather than reducing it.

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