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

A supervisor runs a stress test and finds that a bank meets the 100% LCR on a consolidated basis, but nearly all HQLA sits in a subsidiary in a jurisdiction with capital controls, while most outflows arise in the parent. What is the most appropriate risk management conclusion?

The bank should recognise that trapped liquidity makes the consolidated LCR overstate usable liquidity and should monitor liquidity by significant legal entity and currency. Consolidation assumes free transfer of assets, which capital controls prevent, so the headline ratio can hide a real shortfall at the parent.

  1. ANo concern, since the consolidated LCR is above 100%
  2. BLiquidity transferability constraints mean the consolidated ratio overstates usable liquidity, so the bank should also monitor LCR by significant legal entity and currencyCorrect
  3. CThe bank should replace the LCR with the NSFR because the NSFR ignores location of assets
  4. DThe HQLA should be reclassified as Level 2B to reflect the capital controls

Explanation

Consolidated ratios assume free fungibility of liquidity. Trapped liquidity means the parent may be unable to use the subsidiary's HQLA, so entity-level and currency-level monitoring is needed. The NSFR does not solve transferability and reclassification is not the remedy.

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