Risk Management: Capital, Liquidity and Stress Testing
What this domain tests
Risk Management tests the risk taxonomy, enterprise risk framework, capital and liquidity adequacy, stress testing and operational resilience. Expect questions on limits, escalation and the difference between capital and liquidity.
Core rules
- Main risk types include credit, market, liquidity, operational, conduct, strategic and climate risk.
- Risk appetite translates into limits, triggers and escalation. Breaches need remediation and board reporting.
- ICAAP assesses capital adequacy under stress; recovery planning sets actions before and during stress.
- The Liquidity Coverage Ratio requires high-quality liquid assets to cover 30-day net outflows at 100% or more. The Net Stable Funding Ratio covers one-year funding stability.
- Operational risk uses loss data, risk and control self-assessments and key risk indicators.
- Stress testing should include severe but plausible scenarios and reverse stress testing.
Worked example
A bank has €130 million of high-quality liquid assets and €100 million of net outflows, so its Liquidity Coverage Ratio is 130%. A stress raises outflows by 15% to €115 million, cutting the ratio to 113%. That remains above 100%, but if the internal buffer is 110%, the bank is close to its trigger and should activate its contingency funding plan. A 30% outflow rise would take the ratio to 100%, leaving no headroom.
Traps
- Confusing the Liquidity Coverage Ratio with the Net Stable Funding Ratio.
- Treating value at risk as a maximum loss.
- Running one stress scenario only.
- Assuming liquidity and capital are interchangeable.