Charta is on Google Play: practise on the go. Get the app
Charta

Describe what good practice looks like when building a robust contingency funding plan.

FRM® Part II · Liquidity and Treasury Risk Measurement and Management · Contingency Funding Planning · FRM2.LTR.11.b

The idea

Good practice follows the Basel principles for sound liquidity risk management. A CFP is a formal, documented plan approved by the board or its delegate. It covers firm-specific stress, market-wide stress, and a combination of the two. It names owners with deputies, sets out a ranked menu of actions by speed, amount, cost and signalling effect, and includes a communication plan for regulators, counterparties, depositors, rating agencies and staff. Actions must be operationally ready: collateral pre-positioned, legal documents signed, and funding lines tested with small live transactions. Central bank facilities are treated as a backstop, not a primary source. The plan is tested through exercises and updated regularly and after material changes. A plan that exists only on paper is the usual failure.

A practice question

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

Which description best fits a contingency funding plan that follows good practice?

  1. An informal set of ideas held by the treasurer, who is trusted to improvise when a stress event occurs.Why not: Relies on improvisation: good practice requires a formal documented plan, not individual judgement under pressure.
  2. A formal, documented plan that is tested regularly and updated, with clear roles and responsibilities. - correct
  3. A plan written once at launch and revisited only after an actual liquidity event has damaged the bank.Why not: Updates only after the event: good practice is regular testing and updating, and updating when conditions change.
  4. A plan limited to events specific to the bank, since market-wide stress is covered by the central bank.Why not: Ignores market-wide stress: the plan should cover firm-specific, market-wide and combined scenarios.

Good practice is a formal, documented plan with named owners, covering several kinds of stress, and regularly tested and updated. An untested or improvised plan fails when needed.

A harder one

A bank's CFP lists a repo line with a dealer and a credit line from a correspondent bank as key actions. Which test gives the best evidence that these actions would work in a crisis?

  1. Periodic small live transactions that exercise documents, collateral transfer and settlement. - correct
  2. An annual desk review of the policy document to confirm that the lines are still described in the plan.Why not: A paper review does not prove that documentation, collateral movement and settlement work in practice.
  3. A back-test of the bank's value-at-risk model to confirm that trading losses stay inside limits.Why not: Uses a market-risk test: a VaR back-test says nothing about whether funding actions are operationally ready.
  4. A written confirmation from the dealer that it values the bank as a counterparty in normal markets.Why not: Normal-market goodwill is not evidence about stressed access: only an executed transaction tests readiness.

Good practice is to confirm operational readiness: documents in place, collateral eligible and pre-positioned, systems able to settle. Small live drawings and exercises show this; paper reviews do not.

The hardest tier

A bank's CFP names the central bank's emergency lending facility as the first action in every scenario, with collateral not yet pre-positioned. What is the most serious weakness from a good-practice perspective?

  1. The facility carries a lower interest rate than market funding, so using it first understates the cost of the plan and its overall funding need.Why not: Mixes up the point: the problem is access, stigma and readiness, not that the facility is too cheap.
  2. It makes a last-resort source with stigma and lead time the primary one, ahead of the buffer and market sources. - correct
  3. Central banks do not accept any collateral from banks, so no plan can ever include the facility.Why not: Factually wrong: central banks lend against eligible collateral, and the facility can appear in a plan as a backstop.
  4. The plan should state the central bank's lending rate as a stress-test input rather than as an action.Why not: Mislabels the issue: the facility is a legitimate backstop action, but it should not be the first line of defence.

Central bank facilities are a backstop. Good practice is to use them as a last resort, pre-position collateral and rely first on the buffer and market sources. A plan that starts with the backstop signals distress and may not deliver in time.

In the app: 6 practice questions on this outcome, spaced review that brings it back before you forget it.

Start free →

More in Contingency Funding Planning