CRA Liquidity Risk Management 2 — Questions and Answers
Question 1: Intraday liquidity risk refers to:
- The risk of overnight funding shortfalls in the interbank market
- The risk of being unable to meet payment obligations during the business day when they fall due (Correct answer)
- The risk arising from currency mismatches in cross-border daily transactions
- The risk that settlement system failures cascade during peak trading hours
Correct answer: The risk of being unable to meet payment obligations during the business day when they fall due
Intraday liquidity risk is the risk that a firm cannot meet time-critical payment obligations during the day, potentially causing payment system gridlock.
Question 2: Which of the following assets is NOT typically eligible as a High-Quality Liquid Asset (HQLA) under Basel III?
- Cash held at the central bank
- Government securities carrying a 0% risk weight
- Equity securities listed on a major exchange with a large free float
- Investment-grade corporate bonds rated below AA- (Correct answer)
Correct answer: Investment-grade corporate bonds rated below AA-
Only corporate bonds rated AA- or higher qualify as Level 2B HQLA; bonds rated below AA- do not meet the eligibility threshold.
Question 3: A Contingency Funding Plan (CFP) is primarily designed to:
- Set daily transaction limits on interbank lending exposures
- Identify alternative funding sources and specify actions to be taken during a liquidity crisis (Correct answer)
- Calculate and report the bank's LCR on a daily basis to regulators
- Establish credit risk appetite thresholds for the loan portfolio
Correct answer: Identify alternative funding sources and specify actions to be taken during a liquidity crisis
A CFP documents the triggers, escalation procedures, funding sources, and actions a bank will deploy in response to a liquidity stress event.
Question 4: Asset-liability mismatch risk arises primarily when:
- A bank's credit quality deteriorates faster than its peer group average
- Short-term liabilities are used to fund long-term assets, creating a structural refinancing gap (Correct answer)
- A bank holds an excessively large proportion of government bonds relative to corporate bonds
- The bank's trading portfolio becomes concentrated in a single industry sector
Correct answer: Short-term liabilities are used to fund long-term assets, creating a structural refinancing gap
Asset-liability mismatch occurs when liabilities mature before the assets they fund, exposing the bank to rollover and refinancing risk.
Question 5: In liquidity risk management, a bank's survival horizon represents:
- The maximum permitted maturity of high-quality liquid assets in the HQLA buffer
- The length of time the bank can sustain operations using its liquidity buffer without external market access (Correct answer)
- The minimum LCR compliance period established by the regulator
- The estimated time required to fully liquidate the bank's trading book in an orderly manner
Correct answer: The length of time the bank can sustain operations using its liquidity buffer without external market access
The survival horizon measures how long a bank can continue operating in a stress scenario relying solely on its existing liquidity reserves without new funding.
Question 6: The 'cliff effect' in liquidity risk most commonly refers to:
- A sudden drop in asset market values triggered by credit rating downgrades
- A sharp increase in collateral requirements or accelerated debt repayment triggered when credit ratings fall below contractual thresholds (Correct answer)
- The rapid erosion of HQLA caused by increasing repo market haircuts
- The sudden loss of correspondent banking relationships following a reputational event
Correct answer: A sharp increase in collateral requirements or accelerated debt repayment triggered when credit ratings fall below contractual thresholds
Rating triggers embedded in contracts can cause large, sudden increases in collateral posting or acceleration of debt repayment when ratings breach specified thresholds.
Question 7: Which of the following best describes the purpose of liquidity stress testing?
- Backtesting historical liquidity models against realized outflow data to check accuracy
- Simulating severe but plausible adverse scenarios to assess whether a firm's liquidity buffers are sufficient (Correct answer)
- Calculating the LCR and NSFR under baseline business-as-usual conditions
- Measuring the bid-ask spreads of the bank's asset portfolio to assess market liquidity
Correct answer: Simulating severe but plausible adverse scenarios to assess whether a firm's liquidity buffers are sufficient
Liquidity stress testing involves constructing institution-specific, market-wide, and combined stress scenarios to evaluate the adequacy of the liquidity buffer.
CRA Liquidity Risk Management 2
Intraday liquidity risk refers to: