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FRM Part II · FRM Exam Part II · Contingency Funding Planning

During a liquidity stress test, a risk manager notes that the bank's assumed 10% runoff of corporate deposits was based on the last three years of benign data. Which is the most appropriate criticism and response?

The assumption is likely too lenient because it relies on benign data. The bank should calibrate runoff rates to stressed episodes and informed judgment, and review them regularly, since depositor behavior changes sharply and non-linearly under stress and benign history understates it.

  1. AAssumptions are acceptable because historical data is objective; no change is needed
  2. BAssumptions may be too lenient; calibrate to stressed episodes and expert judgment, and review them regularlyCorrect
  3. CAssumptions should be set to zero runoff since corporate deposits are operational
  4. DAssumptions should be removed and replaced with the regulatory ratio only

Explanation

Benign-period data understates behavior under stress, as liquidity events are rare and non-linear. Sound practice calibrates assumptions to stress episodes, peer or crisis experience and judgment, and reviews them periodically. Zero runoff or relying only on a regulatory ratio ignores bank-specific risk.

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