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

When calibrating the severity of a liquidity stress scenario, which approach best reflects supervisory expectations for scenario design?

Scenarios should blend historical episodes with hypothetical, forward-looking shocks that are severe but plausible and tailored to the bank's own business model and vulnerabilities. Relying only on past events, standardizing across banks, or calibrating to pass would miss institution-specific risks and undermine the test.

  1. AUse only the worst historical outcome observed at the bank itself, without any hypothetical elements
  2. BCombine historical experience with hypothetical, forward-looking shocks that are severe but plausible, and tailor them to the bank's own business model and vulnerabilitiesCorrect
  3. CSet severity so the bank always passes, so that the contingency funding plan is never triggered
  4. DUse identical run-off rates for all banks to ensure comparability, regardless of funding mix

Explanation

Good scenarios are severe but plausible, draw on historical episodes and hypothetical shocks, and are tailored to the institution's specific risk drivers. Purely historical or one-size-fits-all designs miss new vulnerabilities, and engineering a pass defeats the purpose.

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