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Contrast the varieties of liquidity risk report and read their results.

FRM® Part II · Liquidity and Treasury Risk Measurement and Management · Liquidity Risk Reporting and Stress Testing · FRM2.LTR.10.b

The idea

Liquidity reports differ in what question they answer. A contractual maturity ladder lists cash inflows and outflows in time buckets. The gap in each bucket is inflows minus outflows, and the cumulative gap adds them up, so the largest cumulative shortfall is the number that matters, not the single-bucket gap. A behavioural ladder replaces contractual dates with expected behaviour, for example treating stable deposits as long dated. The liquidity coverage ratio is high quality liquid assets divided by net cash outflows over 30 days of stress and must be at least 100 percent. The net stable funding ratio is available stable funding divided by required stable funding over one year, also at least 100 percent. Concentration, encumbrance, intraday and currency reports expose what a consolidated ratio hides. Do not invert the ratios, and read each report for its own question.

Formulas

Liquidity coverage ratio

LCR = HQLA ÷ NCO

HQLA
the stock of high-quality liquid assets
NCO
net cash outflows over a 30-day stress period

Must be at least 100%. A consolidated ratio can hide a shortfall in one currency, so read it by significant currency too.

Net stable funding ratio

NSFR = ASF ÷ RSF

ASF
available stable funding, each liability and equity item weighted by its ASF factor
RSF
required stable funding, each asset weighted by its RSF factor

Must be at least 100%. ASF is the numerator; inverting the ratio turns a shortfall into an apparent surplus.

Cumulative gap in a maturity ladder

Cumulative gap = Σ(In − Out)

In
inflows in each bucket, from the first up to the one being read
Out
outflows in the same buckets

The largest negative cumulative gap is the funding need, not the biggest single-bucket gap. A later surplus bucket reduces it, so the final figure need not be the peak.

A practice question

From the question bank, with the reason each wrong option is wrong.

In a contractual maturity ladder (liquidity gap report), what does the cumulative gap for a time bucket show?

  1. The running total of contractual inflows minus outflows, from the first bucket to the end of that bucket - correct
  2. The difference between total assets and total liabilities across the whole balance sheet at the reporting dateWhy not: Confuses the gap report with a balance-sheet identity; the ladder is about the timing of cash flows.
  3. The ratio of high quality liquid assets to the net cash outflows falling in that bucketWhy not: Confuses the cumulative gap with the liquidity coverage ratio, which is a 30-day ratio, not a running total.
  4. The gap in that bucket alone, expressed as a percentage of total fundingWhy not: Uses a single-bucket, scaled figure; the cumulative gap adds the buckets in sequence and is not a percentage.

Each bucket's gap is inflows minus outflows; the cumulative gap is the running sum from the first bucket. It tells the reader how much funding must be found by a given date.

A harder one

A bank's contractual maturity ladder shows the following (USD million) inflows and outflows by bucket: overnight 120 and 400; 2 to 7 days 260 and 300; 8 to 30 days 310 and 420; 1 to 3 months 500 and 380. Which statement correctly reads the report?

  1. The largest shortfall is 280, in the overnight bucket, since that bucket has the biggest single gapWhy not: Uses non-cumulative bucket gaps; the cumulative gap is what measures the funding that must be found.
  2. The peak cumulative shortfall is 430, after the 8 to 30 day bucket - correct
  3. The cumulative shortfall peaks at 310, at the end of the 1 to 3 month bucketWhy not: Reads the final cumulative figure (-280 -40 -110 +120 = -310) as the peak, ignoring that the 1 to 3 month surplus has already reduced the shortfall.
  4. The 8 to 30 day shortfall is 110, so the bank needs only 110 of funding over the first monthWhy not: Reads the single-bucket gap and ignores the 320 already accumulated in earlier buckets.

Bucket gaps are -280, -40, -110 and +120. Cumulative gaps are -280, -320, -430 and -310, so the peak need is 430 at the end of the 8 to 30 day bucket.

The hardest tier

A bank reports a consolidated LCR of 110 percent. Its HQLA are USD 40 million in US dollars and USD 180 million in euros, and its net 30-day stressed outflows are USD 100 million equivalent in each currency. What is the best reading of this report?

  1. The dollar LCR is only 40 percent against 180 percent in euros, so the 110 percent masks a currency mismatch - correct
  2. The bank is compliant with margin to spare, because euro surplus can always be converted into dollars at normal prices under stressWhy not: Assumes free convertibility of currencies in stress, which is the very assumption that reporting by significant currency is designed to test.
  3. The LCR should be restated as the simple average of 40 and 180 percent, which is 110 percent, confirming the consolidated figureWhy not: Mistakes a coincidence of arithmetic for confirmation; the point is that the average hides the 40 percent shortfall.
  4. The only issue is a euro excess of USD 80 million of HQLA, which should be reduced to improve returnWhy not: Looks at the euro surplus and ignores the dollar deficit; the risk lies in the shortfall currency, not the surplus.

Consolidated LCR = (40 + 180) / (100 + 100) = 110 percent, but the dollar LCR is 40 / 100 = 40 percent. A currency breakdown reveals that the consolidated ratio relies on conversion of euros into dollars during stress.

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