Chapter 30: Liquidity Management (CAIIB – Paper 2)
1. What is the primary objective of liquidity management in a bank?
A. Maximizing profitability only
B. Minimizing regulatory reporting
C. Ensuring sufficient cash and liquid assets to meet obligations
D. Expanding the branch network
Liquidity management ensures that the bank has enough cash or liquid assets to meet its short-term obligations, without compromising profitability.
2. Which of the following is NOT a dimension of liquidity risk?
A. Funding liquidity risk
B. Credit rating risk
C. Market liquidity risk
D. Operational liquidity risk
The main dimensions of liquidity risk include funding liquidity risk and market liquidity risk. Credit rating risk is related to creditworthiness, not liquidity.
3. Liquidity risk management helps a bank in which of the following ways?
A. Avoiding default on short-term obligations
B. Reducing long-term interest rates
C. Increasing employee productivity
D. Expanding the loan portfolio irrespective of funding
Effective liquidity risk management ensures that a bank can meet its short-term obligations, preventing defaults and maintaining stability.
4. Which of the following best describes 'market liquidity risk'?
A. Risk of operational failure affecting cash flows
B. Risk arising from loan defaults by borrowers
C. Risk of sudden regulatory changes
D. Risk that assets cannot be sold quickly without significant loss in value
Market liquidity risk arises when a bank cannot quickly convert assets into cash at reasonable prices, potentially leading to losses.
5. Which of the following is a key role of liquidity risk management in a bank?
A. Maximizing short-term profits without risk consideration
B. Ensuring regulatory compliance and financial stability
C. Reducing the number of branches
D. Avoiding investment in government securities
Liquidity risk management helps banks comply with regulations, maintain financial stability, and ensure the ability to meet obligations even in stressed situations.
6. Which ratio is commonly used to measure a bank’s short-term liquidity position?
A. Current Ratio
B. Debt-Equity Ratio
C. Return on Assets
D. Capital Adequacy Ratio
The Current Ratio measures a bank’s ability to meet short-term obligations with its current assets, helping assess liquidity risk.
7. What is the primary purpose of a Contingency Funding Plan (CFP)?
A. To maximize long-term profitability
B. To reduce employee costs
C. To ensure availability of funds during liquidity stress
D. To avoid compliance with liquidity regulations
A CFP outlines strategies for obtaining liquidity during stress scenarios, ensuring the bank can meet obligations even in crises.
8. Liquidity Coverage Ratio (LCR) is designed to:
A. Measure long-term profitability of the bank
B. Ensure banks hold enough high-quality liquid assets to survive a 30-day stress period
C. Regulate employee incentives in liquidity management
D. Monitor loan recovery performance
LCR requires banks to maintain sufficient high-quality liquid assets to withstand a 30-day period of liquidity stress.
9. Which of the following is a key method to manage liquidity risk?
A. Ignoring short-term obligations
B. Expanding branch network aggressively
C. Reducing capital adequacy
D. Maintaining sufficient liquid assets and diversifying funding sources
Managing liquidity risk involves holding enough liquid assets and diversifying funding sources to meet obligations under normal and stressed conditions.
10. What does 'Funding Liquidity Risk' specifically refer to?
A. Risk that a bank cannot meet its cash flow obligations due to lack of funds
B. Risk arising from changes in interest rates
C. Risk of credit default by borrowers
D. Risk of operational failure
Funding liquidity risk is the risk that a bank will be unable to meet its obligations as they fall due because of insufficient funds.
11. Caselet: A bank notices that its current ratio has fallen below 1.0 due to sudden withdrawal of large deposits. To maintain liquidity, it plans to sell part of its government securities. What is the immediate concern of the bank in this scenario?
A. Increasing long-term profitability
B. Expanding loan portfolio immediately
C. Ensuring sufficient cash to meet obligations
D. Reducing employee costs
The bank’s primary concern is maintaining liquidity to meet immediate withdrawal demands, which may involve selling liquid assets like government securities.
12. Caselet: During a stress test, a bank finds that it may not have enough high-quality liquid assets to survive a 30-day stress scenario. Which regulatory requirement is it likely failing to meet?
A. Net Stable Funding Ratio (NSFR)
B. Liquidity Coverage Ratio (LCR)
C. Capital Adequacy Ratio (CAR)
D. Loan-to-Deposit Ratio (LDR)
LCR ensures that banks maintain sufficient high-quality liquid assets to survive a 30-day liquidity stress scenario. Failure indicates non-compliance with LCR requirements.
13. Caselet: A regional bank is facing sudden deposit outflows due to a local market panic. It considers borrowing from the interbank market but the rates are unusually high. Which aspect of liquidity risk is the bank experiencing?
A. Credit risk
B. Operational risk
C. Market risk
D. Funding liquidity risk
The bank is facing funding liquidity risk, as it struggles to obtain funds to meet withdrawal demands due to stressed market conditions.
14. Caselet: A bank’s treasury team is monitoring asset liquidity. They notice that selling some corporate bonds would take longer than expected and could incur losses. What type of liquidity risk does this scenario illustrate?
A. Operational liquidity risk
B. Market liquidity risk
C. Funding liquidity risk
D. Credit risk
Market liquidity risk arises when a bank cannot quickly convert assets into cash at fair value, potentially leading to losses.
15. Caselet: A bank prepares a contingency funding plan (CFP) for potential liquidity crises. The plan includes liquidating assets, borrowing from other banks, and accessing central bank facilities. What is the primary benefit of this CFP?
A. Reducing long-term interest rate risk
B. Maximizing short-term profits
C. Ensuring the bank can meet obligations during stress periods
D. Avoiding regulatory audits
The CFP ensures that a bank has predefined strategies to handle liquidity stress, helping it meet obligations even during crises.
