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FRM Part II · FRM Exam Part II · Liquidity Risk Reporting and Stress Testing

Which feature of a liquidity stress test most directly helps a board decide whether the bank's liquidity risk appetite is appropriate?

Reverse stress testing is most useful. By starting from the point where liquidity is exhausted and identifying which shocks would cause it, it shows how much cushion exists and lets the board judge whether the stated liquidity risk appetite is suitably conservative.

  1. AReverse stress testing that identifies the conditions under which the bank's liquidity would be exhaustedCorrect
  2. BUsing only regulatory ratio calculations without internal scenarios
  3. CExcluding off-balance sheet commitments to simplify results
  4. DRunning the test once a year only

Explanation

Reverse stress testing starts from the failure outcome and finds the scenarios that cause it, showing how close the bank is to its limits and informing appetite. The other options reduce coverage or frequency and weaken decision usefulness.

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