Module: | MODULE B: RISK MANAGEMENT
Q428: Consider the following statements regarding the relationship between Non-Performing Assets and Liquidity Risk:
1. A sudden spike in gross Non-Performing Assets permanently traps anticipated cash inflows, directly deteriorating the bank's liquidity position.
2. To compensate for the non-receipt of expected inflows from Non-Performing Assets, banks are forced to raise high-cost market borrowings, leading to Time Risk.
3. High Non-Performing Assets improve the Net Stable Funding Ratio by artificially reducing the Required Stable Funding parameter.
Which of the statements given above is/are correct?
2. To compensate for the non-receipt of expected inflows from Non-Performing Assets, banks are forced to raise high-cost market borrowings, leading to Time Risk.
3. High Non-Performing Assets improve the Net Stable Funding Ratio by artificially reducing the Required Stable Funding parameter.
Which of the statements given above is/are correct?
✅ Correct Answer: A
The correct answer is A. Statement 1 is correct: High Non-Performing Assets (NPAs) create a severe drag on liquidity.
Loans that default trap anticipated principal and interest cash inflows, causing a structural disruption in the bank's expected cash flow pipeline.
Statement 2 is correct: This disruption leads to 'Time Risk'. Since the bank's liabilities (deposits) still mature on time, the non-receipt of expected loan inflows forces the bank into the wholesale market to raise high-cost, short-term emergency funds to bridge the gap.
Statement 3 is incorrect: High NPAs do not improve the Net Stable Funding Ratio (NSFR); they severely degrade it.
Under Basel III guidelines, non-performing loans are considered highly illiquid assets and therefore attract a much higher Required Stable Funding (RSF) factor (often 100%). This higher RSF demand lowers the overall NSFR, indicating a weaker liquidity profile.
Loans that default trap anticipated principal and interest cash inflows, causing a structural disruption in the bank's expected cash flow pipeline.
Statement 2 is correct: This disruption leads to 'Time Risk'. Since the bank's liabilities (deposits) still mature on time, the non-receipt of expected loan inflows forces the bank into the wholesale market to raise high-cost, short-term emergency funds to bridge the gap.
Statement 3 is incorrect: High NPAs do not improve the Net Stable Funding Ratio (NSFR); they severely degrade it.
Under Basel III guidelines, non-performing loans are considered highly illiquid assets and therefore attract a much higher Required Stable Funding (RSF) factor (often 100%). This higher RSF demand lowers the overall NSFR, indicating a weaker liquidity profile.