Liquidity Risk Management Flashcards

Liquidity transfer pricing (LTP) is used by banks primarily to:

Answer: Allocate the cost and benefit of liquidity to individual business lines, incentivizing behavior consistent with firm-wide liquidity risk appetite

LTP ensures that business lines consuming or generating liquidity are charged or credited appropriately, aligning their incentives with the firm's overall liquidity risk management.

Early warning indicators (EWIs) for emerging liquidity risk typically include:

Answer: Rising interbank funding costs, increased reliance on central bank facilities, and accelerating retail deposit outflows

EWIs such as widening funding spreads, central bank borrowing, and deposit outflows signal building liquidity stress before it becomes severe.

A liquidity gap analysis is used to:

Answer: Identify mismatches between projected cash inflows and outflows across maturity time buckets

Liquidity gap analysis maps projected cash flows into time buckets to identify periods where outflows exceed inflows, revealing structural funding gaps.

Encumbrance risk in liquidity management refers to:

Answer: The risk that pledged collateral reduces the pool of unencumbered assets available to monetize in a stress scenario

Over-encumbrance leaves fewer freely available unencumbered assets to liquidate during stress, materially reducing the effective liquidity buffer.

In a secured funding transaction, the haircut applied to collateral primarily serves to:

Answer: Protect the cash lender by ensuring collateral value exceeds the loan amount, providing a buffer against price declines

Haircuts protect secured lenders by requiring over-collateralization, ensuring that even if collateral values fall the lender is still covered.

The concept of 'liquidity hoarding' during systemic stress events refers to:

Answer: Financial institutions retaining excess cash balances and refusing to lend in interbank markets, amplifying the funding crisis

Liquidity hoarding occurs when institutions retain excess cash out of precaution and withdraw it from interbank markets, reducing system-wide liquidity availability and amplifying stress.

Which of the following most accurately describes the relationship between market liquidity risk and funding liquidity risk?

Answer: They can reinforce each other: inability to sell assets at fair value worsens funding, and funding stress may force asset sales that depress prices

Market and funding liquidity risks are mutually reinforcing: forced asset sales depress prices, worsening funding conditions and triggering further sales in a downward spiral.