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

A risk manager distinguishes between funding liquidity risk and market liquidity risk. Which situation is the clearest example of funding liquidity risk?

Funding liquidity risk is the inability to meet payment obligations when due because funding cannot be obtained or rolled over. Wholesale lenders refusing to roll maturing short-term borrowing is the clearest example; wide spreads on bond sales indicate market liquidity risk instead.

  1. AA bank cannot sell a large block of corporate bonds without moving the price sharply because bid-ask spreads have widened
  2. BA bank's wholesale lenders refuse to roll over maturing short-term borrowing, leaving it unable to meet payments as they fall dueCorrect
  3. CA bank's equity portfolio falls in value because the market index declines by 8%
  4. DA bank's loan book suffers higher defaults because of a recession

Explanation

Funding liquidity risk is the risk of being unable to meet obligations as they fall due because funding cannot be raised or rolled over. The wide bid-ask spread example is market liquidity risk, the equity fall is market risk, and defaults are credit risk.

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