Liquidity Risk
What the exam tests
Liquidity risk tests funding liquidity, market liquidity, cash-flow gaps, and the Basel liquidity ratios. Expect calculations of LCR or NSFR and questions on stress funding and contingency planning.
Core rules and concepts
- Funding liquidity risk is the inability to meet obligations as they fall due without unacceptable cost. Market liquidity risk is the inability to sell an asset quickly at a fair price.
- Liquidity risk can bankrupt a solvent institution; profitability does not guarantee liquidity.
- The LCR requires high-quality liquid assets (HQLA) to cover net cash outflows over 30 calendar days at least 100%.
- The NSFR requires available stable funding to exceed required stable funding over one year, at least 100%.
- Funding concentration, reliance on wholesale deposits, off-balance-sheet commitments, and collateral haircuts are key vulnerabilities.
- A contingency funding plan sets escalation triggers and alternative funding sources.
Worked example
A bank holds PKR 45 billion of HQLA and estimates net cash outflows of PKR 30 billion over 30 days under its stress scenario. LCR = 45/30 = 150%. The minimum is 100%, so the bank has a PKR 15 billion HQLA surplus. The reasoning: the ratio compares the liquidity buffer with stressed outflows, not with total deposits. A high LCR does not prove the bank can survive a longer crisis, so the NSFR and scenario analysis are also needed.
Traps that cost marks
Do not treat a profitable balance sheet as liquid. Do not count all securities as HQLA; haircuts and eligibility matter. Do not use total deposits as the LCR denominator. Do not ignore contingent liabilities and undrawn commitments. Do not assume wholesale funding is stable. Do not confuse the 30-day LCR with the one-year NSFR.