Module: | MODULE B: RISK MANAGEMENT
Q425: Consider the following statements regarding Systemic Risk Contagion and Institution-Specific Liquidity Risk:
1. Institution-specific liquidity risk arises primarily from internal asset-liability mismatches, and can trigger systemic risk if the entity is highly interconnected.
2. Systemic risk contagion occurs when a liquidity shortfall at one bank leads to a cascading failure across the broader financial system.
3. The Reserve Bank of India mandates that only Domestic Systemically Important Banks are required to maintain a Contingency Funding Plan to mitigate contagion.
Which of the statements given above is/are correct?
2. Systemic risk contagion occurs when a liquidity shortfall at one bank leads to a cascading failure across the broader financial system.
3. The Reserve Bank of India mandates that only Domestic Systemically Important Banks are required to maintain a Contingency Funding Plan to mitigate contagion.
Which of the statements given above is/are correct?
✅ Correct Answer: A
The correct answer is A. Statement 1 is correct: Institution-specific liquidity risk originates from poor internal asset-liability management (ALM). If the failing institution is heavily interconnected with other financial entities, its localized failure can easily spread.
Statement 2 is correct: Systemic risk contagion is precisely defined as a scenario where a localized liquidity shortfall or insolvency at one institution triggers a cascading failure, wiping out market confidence and liquidity across the broader financial system.
Statement 3 is incorrect: The Reserve Bank of India (RBI) mandates that ALL commercial banks, regardless of their size or Domestic Systemically Important Bank (D-SIB) status, must formulate a robust Contingency Funding Plan (CFP) to handle severe liquidity stress scenarios.
Statement 2 is correct: Systemic risk contagion is precisely defined as a scenario where a localized liquidity shortfall or insolvency at one institution triggers a cascading failure, wiping out market confidence and liquidity across the broader financial system.
Statement 3 is incorrect: The Reserve Bank of India (RBI) mandates that ALL commercial banks, regardless of their size or Domestic Systemically Important Bank (D-SIB) status, must formulate a robust Contingency Funding Plan (CFP) to handle severe liquidity stress scenarios.