Lecture 10 -Liquidity risk II

Which of the following best describes the regulatory intent behind the Liquidity Coverage Ratio (LCR)?

• To ensure banks maintain profitability during a market downturn

• To require banks to hold sufficient HQLA to withstand a 30-day liquidity stress scenario without relying on central bank's assistance

• To restrict banks from holding risky assets on their balance sheet

• To improve the capital adequacy ratio through short-term funding

A bank holds central bank reserves, sovereign bonds, and AA-rated corporate bonds. Which assets will be fully counted towards Level 1 HQLA under LCR framework

• All of the assets listed

• Only sovereign bonds and corporate bonds

• Only central bank reserves and sovereign bonds

• Only central bank reserves

A bank's HQLA portfolio contains 20% Level B assets and 30% Level 2A. Based on LCR guidelines, which of the following regulatory breaches is most likely?

• Breach of 15% cap on level 2A assets

• Breach of 40% cap on total Level 2 assets

• Breach of 0% cap on Level 2B assets

• No regulatory breach if all assets are marked to market

Under LCR rules, why is a minimum haircut of 50% applied to Level 2B assets in the HQLA calculation?

• Because they are not eligible under normal market conditions

• To reflect higher credit risk associated with sovereign issuers

• To simulate potential devaluation of less liquid assets under stress

• To align with IFRS reporting standards

The Net Stable Funding Ratio (NSFR) is designed to:

• Ensure liquidity during intraday settlement cycles

• Encourage banks to increase their capital reserves during recession

• Align long-term asset holdings with stable funding sources to reduce structural funding risk

• Regulate the leverage ratio of non-bank financial institutions

Which of the following scenarios would most negatively impact a bank's NSFR ratio?

• Increasing holdings in short-term treasury bills

• Converting short-term wholesale debt to long-term deposits

• Increasing long-term mortgage loans funded by overnight repo agreements

• Reducing capital held in the form of Tier 1 capital

What does a consistently declining liquidity index over several quarters most likely indicate for a financial institution?

• The bank is becoming more profitable

• The institution's ability to convert assets into cash under stress is weakning

• The capital adequacy ratio is improving

• The institution is increasing its risk-weighted assets

In the aftermath of the 2008 financial crisis, which structural flaw in global banking systems did the Basel III liquidity framework most directly address?

• Inconsistent risk-weighting of market securities

• Over-reliance on credit rating agency

• Absence of globally harmonized liquidity standards and excessive dependence on short-term wholesale funding

• Inadequate supervision of hedge fund activities

A well-designed Contingency Funding Plan (CFP) is most likely to include which of the following features during a liquidity stress event?

• Purchase of additional long-term loans

• Suspension of Basel III compliance

• Pre-arranged repo agreements and committed credit lines with counterparties

• Reclassification of risky assets to Level 1 status

What lessons from Lehman Brothers' collapse best justifies the introduction of HQLA requirements in LCR?

• High profitability can mask liquidity risk

• Asset-rich institutions can still fail if they lack readily liquid assets during funding pressure

• Tier 2 capital cannot absorb losses

• Market participants ignore credit ratings in crisis