Liquidity Management MCQ: CAIIB BFM Unit 29 Module D

Correct Answer: B. Ensuring profitability and maintaining liquidity. ALM aims to balance the financial institution’s goals of making a profit while ensuring it has enough cash or easily convertible assets to meet its short-term obligations.

Correct Answer: C. Solvency Risk. Severe liquidity risk, which is the inability to meet short-term obligations, can escalate into solvency risk, meaning the institution may be unable to meet its long-term obligations.

Correct Answer: C. Basel III Guidelines. The Basel III guidelines specifically introduced LCR and NSFR as key measures to strengthen liquidity risk management in banks globally.

Correct Answer: B. The ability to meet deposit withdrawals and loan demands efficiently. Liquidity refers to having sufficient funds available promptly and at a reasonable cost to handle outflows like deposit withdrawals and fund new loans.

Correct Answer: C. Market conditions and the institution’s perceived risk. The cost of acquiring funds (price of liquidity) depends on the overall market situation and how risky lenders perceive the borrowing institution to be.

Correct Answer: B. To compensate for balance sheet changes and fund growth opportunities. Liquidity is needed to manage the natural fluctuations in assets and liabilities and to have funds available to support business expansion or new lending.

Correct Answer: B. Sell assets quickly at potentially low prices or borrow expensively. Insufficient liquidity can lead to forced “fire sales” of assets below their true value or borrowing funds under unfavourable, costly terms.

Correct Answer: C. Generating funds to meet various obligations at a reasonable cost. Liquidity management is the ongoing process of ensuring the institution can source enough funds when needed to pay its obligations without incurring excessive costs.

Correct Answer: B. To avoid needing to sell assets quickly at a loss (‘fire sales’). Effective liquidity management helps prevent situations where the institution must sell assets unprofitably due to urgent cash needs, demonstrates safety, helps meet commitments, and can lower the perceived default risk.

Correct Answer: B. A sudden significant rise in Non-Performing Assets (NPAs). An increase in NPAs (loans not being repaid) reduces expected cash inflows and signals higher risk, negatively impacting liquidity. Other factors include falling earnings, deposit concentration, rating downgrades, and major expansions.

Correct Answer: C. Selling off some of its liquid assets. Disposing of assets that can be easily converted to cash is a primary way to meet funding requirements. Other methods include short-term borrowing, reducing less liquid assets, increasing term liabilities, or raising capital.

Correct Answer: D. Funding Risk. Funding risk specifically relates to the challenge of replacing funds that are flowing out (like deposit withdrawals) or renewing maturing debt, especially if market confidence is lost.

Correct Answer: A. When expected cash inflows do not arrive as scheduled. Time risk occurs when anticipated funds, often from loan repayments, are delayed or do not materialize, commonly due to worsening asset quality or loan recovery problems.

Correct Answer: B. The risk that previously uncertain obligations suddenly require payment. Call risk arises when contingent liabilities, like guarantees or credit lines that weren’t certain to be used, suddenly become actual demands for funds.

Correct Answer: B. Yes, multiple liquidity risk factors can occur simultaneously and worsen the situation. It’s possible and often problematic when different liquidity pressures (e.g., deposit outflows and delayed loan repayments) happen concurrently.

Correct Answer: C. Through inter-bank lending and transactions. Problems can spread because institutions often lend to and borrow from each other (inter-bank market). If one institution faces a liquidity crisis, it can impact its ability to repay others, potentially spreading the problem.

Correct Answer: C. They introduce additional complexity and risk factors. Managing liabilities in foreign currencies adds layers of complexity due to exchange rate fluctuations and potential difficulties in accessing foreign currency markets when needed.

Correct Answer: C. It provides valuable time to address the underlying problem. Strong liquidity management ensures the institution can meet immediate needs, buying time to diagnose and manage the root cause of an internal or external crisis.

Correct Answer: B. Continuously monitoring and forecasting funding needs under various conditions. Liquidity analysis is an ongoing process that includes tracking current liquidity and projecting future cash requirements under different possible scenarios.

Correct Answer: B. Developing a structure, setting tolerance/limits, measuring/managing risk. A systematic approach involves establishing a framework for management, defining acceptable risk levels through limits, and actively measuring and controlling the risk.

Correct Answer: C. They must be closely integrated into the business strategy. Liquidity considerations and policies need to be a fundamental part of the bank’s overall strategic planning and decision-making.

Correct Answer: C. The Board of Directors and Senior Management. Ultimate oversight of the liquidity strategy, including setting risk tolerance and ensuring communication, rests with the highest levels of leadership.

Correct Answer: B. By setting specific limits on various liquidity metrics. Banks control their exposure to liquidity risk by establishing clear, quantifiable limits on factors like cash flow mismatches or reliance on certain funding sources.

Correct Answer: C. Reliance on individual funding sources (concentration risk). Limits are commonly set on cumulative cash flow gaps, liquid asset holdings, loan-to-deposit ratios, concentration of funding sources, and liability maturity profiles.

Correct Answer: B. The bank’s own size, complexity, and financial condition. Liquidity limits cannot be one-size-fits-all; they must be customized based on the individual bank’s characteristics and risk profile.

Correct Answer: C. Stock approach and Flow approach. Liquidity measurement is primarily done using either the Stock approach (looking at the balance sheet at a point in time) or the Flow approach (analyzing cash flows over time).

Correct Answer: B. It uses balance sheet data from a specific date and relies on ratios. The stock approach provides a snapshot of liquidity based on balance sheet figures at a particular point in time, often using ratios like liquid assets to total assets.

Correct Answer: C. Examining future cash inflows and outflows over time. The flow approach is dynamic, projecting cash movements across different future time periods, often using a maturity ladder.

Correct Answer: B. Managing access to funding markets. The flow approach encompasses measuring net funding needs, ensuring continued access to funding sources, and having contingency plans.

Correct Answer: C. Maturity Ladder. A maturity ladder is a standard tool that organizes expected cash inflows and outflows into specific future time bands (e.g., next day, next week, next month) to identify potential shortfalls.

Correct Answer: C. Under normal conditions, a bank-specific crisis, and a general market crisis. To be robust, flow analysis should assess funding needs under various stress scenarios, not just normal operations.

Correct Answer: C. Diversifying funding sources and building strong relationships. Ensuring access to funds involves having multiple sources of funding available and maintaining good relationships with those providers.

Correct Answer: B. To develop a strategy for handling liquidity crises effectively. Contingency planning involves creating a pre-defined plan outlining how the bank will manage a severe liquidity shortage or crisis situation.

Correct Answer: B. Clear definition of responsibilities during a crisis. A good contingency plan must specify who is responsible for what actions, ensure timely information flow, outline potential actions, manage communication, and detail access to emergency funds.

Correct Answer: C. Unused credit facilities and central bank credit lines. Contingency plans often identify pre-arranged sources of funds like undrawn lines of credit from other institutions or access to borrowing facilities at the central bank.