Case Study: Design for Liquidity Stress Testing

Abstract

This short working paper brings up a case study pertaining to design and implementation of liquidity stress testing solution. Liquidity risk has been at the forefront of regulatory attention ever since the 2009-09 financial crisis stuck. Banks are required to arrive at a thorough understanding of liquidity profile by subjecting the balance sheets to liquidity stress. Implementation requires identification of liquidity risk drivers and testing the sensitivity of portfolios to them. Arriving at the list of most critical risk drivers helps a bank to focus on them. Scenarios to stress test are created in a subsequent step by subjecting pertinent risk drivers to varying degrees of shocks to understand the liquidity mismatches.

Keywords: Liquidity risk, Financial crisis, Liquidity coverage ratio, Basel III

JEL Classification: E44