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Free FRM Liquidity and Treasury Risk Management Practice Questions & Answers
400 exam-style Liquidity and Treasury Risk Management questions. Pick your answer, hit Check answer, and see the worked solution — free to start, no signup.
100% free · No login to startQuestion 181
A 'reverse stress test' for liquidity differs from conventional stress tests because:
Select an option first.
Correct answer: B — Reverse: starts from failure outcome (liquidity exhausted) and works backwards to identify scenarios causing it — surfacing unknown vulnerabilities. Forward: starts from scenario and computes impact.
Explanation: Reverse liquidity stress test: 'what combination of events exhausts our buffer?' Regulatory expectation for advanced banks.
Question 182
Procyclical margin requirements create systemic risk because:
Select an option first.
Correct answer: B — Rising haircuts during stress force deleveraging, amplifying economic downturns exactly when credit is most needed.
Explanation: Procyclical haircut spiral: stress → higher haircuts → forced deleveraging → more stress → further haircut increases.
Question 183
Under the ILAAP, an adverse scenario must be more severe than LCR because:
Select an option first.
Correct answer: B — LCR is a standardised 30-day scenario; ILAAP must include institution-specific, beyond-30-day, and combined scenarios to demonstrate adequacy under all plausible conditions.
Explanation: ILAAP severity: must go beyond the LCR scenario in time horizon, institution-specificity, and severity.
Question 184
A bank with LCR > 100% can still show an ILAAP shortfall if:
Select an option first.
Correct answer: B — The internal stress scenarios are more severe than LCR; the time horizon extends beyond 30 days; or additional risks not captured by LCR are included. LCR only guarantees the specific 30-day standard scenario.
Explanation: LCR ≠ full adequacy. ILAAP uses bank-specific, longer-horizon scenarios that may reveal gaps not visible in LCR.
Question 185
Regulatory treatment of contingent liabilities in LCR/NSFR applies conservative outflow factors because:
Select an option first.
Correct answer: B — Contingent liabilities represent real potential outflows not visible on the balance sheet — conservative factors ensure these are capitalised against the liquidity buffer.
Explanation: Contingent liability treatment: LCR (5-30% run-off for credit lines); NSFR (5% RSF). Without these, buffers would understate risk.
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Question 186
FSB recommendations on repo market transparency post-2008 aimed to:
Select an option first.
Correct answer: B — Improve data collection to enable macroprudential monitoring of secured funding market stress, haircut trends, and systemic leverage.
Explanation: FSB repo transparency: data reporting on repo volumes, haircuts, rehypothecation, and systemic leverage.
Question 187
Diamond-Dybvig (1983) model's key insight for bank liquidity is:
Select an option first.
Correct answer: B — Bank runs can be self-fulfilling — if depositors expect others to run, it's rational for everyone to run first, creating a bad equilibrium even for a solvent bank. Deposit insurance eliminates this bad equilibrium.
Explanation: Diamond-Dybvig: two equilibria (good: no run; bad: everyone runs). Deposit insurance + LOLR remove the bad equilibrium.
Question 188
The 'usability' concern for the LCR buffer means:
Select an option first.
Correct answer: B — If banks won't let the LCR fall below 100% in stress (fearing regulatory stigma or market signalling), the buffer cannot function as intended — regulators must communicate that buffers are designed to be used.
Explanation: Buffer usability: if markets punish any LCR drawdown, banks won't use the buffer → it provides no real resilience. Regulators must manage market expectations around buffer usage.
Question 189
A bank with strong NSFR but very high funding concentration in one wholesale counterparty still faces:
Select an option first.
Correct answer: B — Name concentration cliff risk — if that single counterparty suddenly withdraws, the bank faces a sudden large funding shortfall even though the overall funding maturity profile appears stable.
Explanation: NSFR captures maturity stability but not concentration. A single large funder withdrawing creates an instant cliff regardless of NSFR.
Question 190
The 'Resolution and Recovery Planning' interaction with liquidity means:
Select an option first.
Correct answer: B — Banks must demonstrate adequate pre-positioned liquidity in each resolution entity, maintain liquid assets free from intragroup encumbrance, and plan for potential loss of market access during resolution.
Explanation: Resolution liquidity pre-positioning: RLEN, pre-positioned HQLA in resolution entities, intragroup liquidity agreements, no cross-pledge of resolution entity assets.
Question 191
The 'Internal Liquidity Stress Test' (ILST) must cover which minimum set of scenarios for a large international bank?
Select an option first.
Correct answer: B — At minimum: a 30-day combined scenario (idiosyncratic + systemic), an extended (90-day+) scenario, an institution-specific severe scenario, and a reverse stress test — across all material currencies and legal entities.
Explanation: ILST scope for large banks: multiple time horizons (30-day, 90-day, 1-year), multiple scenario types (LCR-equivalent, institution-specific, reverse), multiple currencies and entities.
Question 192
What is the most likely cause of a bank that passes LCR, NSFR, and all internal liquidity metrics but still fails suddenly?
Select an option first.
Correct answer: B — Model risk or 'unknown unknowns' — a liquidity risk that is not captured by any of the standard metrics, such as an untested payment system dependency, a hidden intragroup encumbrance, or a new digital-era bank run dynamic.
Explanation: Model risk in liquidity: SVB passed pre-crisis LCR-equivalent metrics. The concentrated uninsured depositor digital run was not adequately captured. No metric set is complete — resilience also requires judgment, governance, and operational readiness.
Question 193
A bank's 'liquidity stress test governance' requires that stress test results are:
Select an option first.
Correct answer: B — Reviewed and challenged by the ALCO and board, documented, used in ILAAP and CFP design, and reported to supervisors — with clear escalation triggers if metrics breach risk appetite thresholds.
Explanation: Stress test governance: results flow to ALCO and board, inform risk appetite, CFP, and ILAAP, and trigger action if metrics breach thresholds.
Question 194
The 'Bank Recovery and Resolution Directive' (BRRD) in Europe requires banks above a certain size to:
Select an option first.
Correct answer: B — Develop and maintain a recovery plan (self-help actions in stress) and cooperate with resolution authorities to develop a resolution plan (orderly wind-down without taxpayer funds).
Explanation: BRRD: recovery plan (bank-designed self-rescue) + resolution plan (regulator-designed orderly failure). Both are essential elements of crisis preparedness.
Question 195
The 'Minimum Requirement for Own Funds and Eligible Liabilities' (MREL) in Europe serves to:
Select an option first.
Correct answer: B — Ensure banks maintain sufficient bail-in-able liabilities so that losses can be absorbed and the bank recapitalised in resolution without public funds.
Explanation: MREL (EU equivalent of TLAC): ensures sufficient loss-absorbing capacity for resolution without taxpayer support. Key component of post-2008 'too big to fail' reforms.
Question 196
The 'EBA Guidelines on ILAAP' (EBA/GL/2016/10) require banks to assess which time horizons for liquidity?
Select an option first.
Correct answer: B — Short-term (intraday, overnight, up to 30 days), medium-term (up to 1 year), and long-term (structural, beyond 1 year) — a comprehensive multi-horizon approach.
Explanation: EBA ILAAP guidelines: comprehensive multi-horizon assessment — intraday, short-term, medium-term, and structural/long-term. All must be covered.
Question 197
The 'internal governance' requirements for ILAAP under EBA guidelines assign ultimate responsibility for liquidity adequacy to:
Select an option first.
Correct answer: B — The management body (board of directors or supervisory board) — which must understand the bank's liquidity risk profile and ensure adequate liquidity is maintained.
Explanation: Board responsibility for ILAAP: board has ultimate governance accountability for liquidity adequacy. They must understand and challenge liquidity risk, not just rubber-stamp management reports.
Question 198
Under the Basel 'Supervisory Monitoring Tools' (BCBS 248), the 'available unencumbered assets' metric provides supervisors with:
Select an option first.
Correct answer: B — Information on unencumbered assets that could serve as collateral or be sold to generate liquidity — beyond just the HQLA qualifying assets, including lower-quality assets that could generate emergency liquidity.
Explanation: Available unencumbered assets: broader than HQLA — includes all assets that could generate liquidity in stress (haircut applied). Enables supervisors to assess total monetisation capacity.
Question 199
The 'recovery indicators' in a bank's recovery plan are metrics that:
Select an option first.
Correct answer: B — Trigger the activation of recovery plan actions when breached — such as CET1 ratio falling below a threshold, LCR falling below a level, or CDS spread exceeding a threshold.
Explanation: Recovery indicators: pre-set triggers that activate recovery actions. E.g., CET1 < 10%, LCR < 110%, CDS > 300bp. They provide an objective escalation framework.
Question 200
The 'Single Resolution Board' (SRB) in Europe determines which banks are within its remit based on:
Select an option first.
Correct answer: B — Systemic importance — banks directly supervised by the ECB (SIs) and cross-border banking groups within the Banking Union are subject to SRB resolution authority.
Explanation: SRB remit: ECB-supervised significant institutions + cross-border banking groups in the Eurozone Banking Union. National Resolution Authorities (NRAs) handle less significant institutions.
Question 201
The 'liquidity risk tolerance' statement in a bank's risk appetite framework should be approved by:
Select an option first.
Correct answer: B — The board of directors — as it defines the maximum acceptable liquidity risk the institution can bear and is fundamental to the bank's risk appetite.
Explanation: Board approval: risk appetite/tolerance is a board-level governance document. The board is responsible for setting the boundaries within which management operates.
Question 202
The 'Basel Committee on Banking Supervision' (BCBS) develops global banking standards. Its liquidity standards are:
Select an option first.
Correct answer: B — Agreed international standards that member jurisdictions agree to implement through their own national laws and regulations — ensuring global consistency while allowing some national variation.
Explanation: BCBS standards: member jurisdictions implement through domestic law (CRD/CRR in EU, US Federal Reserve rules, UK PRA rules). BCBS does not directly regulate banks.
Question 203
The 'harmonised reporting framework' (COREP) in Europe requires banks to submit:
Select an option first.
Correct answer: B — Standardised regulatory reports to their national supervisor in a common EU format — including LCR, NSFR, own funds, and ALMM data — enabling EU-wide supervisory aggregation.
Explanation: COREP: EU-standardised supervisory reporting framework. All EU banks submit LCR, NSFR, capital, and ALMM in common format enabling EBA aggregation and comparison.
Question 204
When a central bank provides 'emergency liquidity assistance' (ELA), this differs from standard monetary policy operations because:
Select an option first.
Correct answer: B — ELA is provided to individual banks facing acute liquidity stress at the national central bank's discretion and risk — unlike standard OMOs which are systemic tools for all banks.
Explanation: ELA: national CB discretionary facility for specific distressed banks. Different from standard open market operations available to all banks. ELA costs higher than standard CB operations; national CB bears the risk.
Question 205
The 'Supervisory Liquidity Assessment Framework' (SLAF) under the PRA in the UK requires banks to:
Select an option first.
Correct answer: B — Demonstrate through the ILAAP that they can meet their 'Individual Liquidity Guidance' (ILG) — the PRA's bank-specific liquidity requirement reflecting the bank's individual risk profile.
Explanation: UK PRA SLAF: ILG is the PRA's bank-specific liquidity standard based on ILAAP review. ILG = buffer requirement above the standard LCR minimum.
Question 206
The 'Fundamental Principles of Liquidity Risk Management' issued by the Basel Committee require banks to have a 'sound liquidity risk management process' that at minimum includes:
Select an option first.
Correct answer: B — Robust liquidity risk governance (board/ALCO oversight), measurement systems covering all risk dimensions, stress testing, a CFP, and a liquidity buffer — integrated into the overall risk management framework.
Explanation: Basel 2008 minimum principles: governance + measurement + stress testing + CFP + buffer. This comprehensive framework is the baseline for all bank liquidity management globally.
Question 207
The 'Procyclicality Workstream' at the Financial Stability Board (FSB) post-2008 focused on:
Select an option first.
Correct answer: B — Reducing the tendency of financial regulation and bank behaviour to amplify economic cycles — through countercyclical capital buffers, through-the-cycle LGD estimates, and forward-looking provisioning.
Explanation: FSB/BIS procyclicality work: CCyB, IFRS 9 forward-looking provisions, through-the-cycle IRB calibration, and repo market reform. All aimed at smoothing financial cycles.
Question 208
The 'Sustainable Finance Disclosure Regulation' (SFDR) in Europe is relevant to bank liquidity risk management because:
Select an option first.
Correct answer: B — Climate-related financial risks (physical and transition) can materially affect the credit quality of collateral and the stability of funding — banks must assess and disclose these risks as they interact with their liquidity position.
Explanation: Climate-liquidity interaction: physical risks (flooding damage to collateral), transition risks (stranded asset repricing), and ESG-related funding flows can all affect bank liquidity. Increasingly integrated into ILAAP and supervisory review.
Question 209
The '2019 Financial Stability Board review' of the implementation of G-SIB resolution frameworks found:
Select an option first.
Correct answer: B — Significant progress had been made, but important gaps remained — particularly in resolution liquidity (RLEN), operational continuity in resolution, and cross-border cooperation among resolution authorities.
Explanation: FSB G-SIB resolution review (2019): progress recognised but gaps identified — resolution liquidity, operational continuity (maintaining IT systems), and international coordination remain challenging.
Question 210
The 'PRA liquidity stress test' framework in the UK (under PS2/19) distinguishes between:
Select an option first.
Correct answer: B — 'Core' liquidity risk (idiosyncratic + market-wide) and 'stressed HQLA' scenarios — requiring banks to demonstrate survival under both their own idiosyncratic stress and a concurrent market-wide stress.
Explanation: UK PRA liquidity stress: core stress = 3-month idiosyncratic + market-wide combined scenario. Banks must demonstrate survival with HQLA minus stressed outflows ≥ 0 at each time point.
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