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October 31, 2017

IMF published a working paper that outlines a framework to perform liquidity stress tests for investment funds. The paper discusses practical aspects related to the calibration of the redemption shock, the measurement of liquidity buffers, and the assessment of resilience of investment funds. The integration of liquidity stress tests with banking sector stress tests and possible bank-fund inter-linkages are also covered.

In the banking sector, solvency and liquidity stress tests have been performed for a long time and regulators have provided the industry with guidance. However, in the fund industry, there has been little guidance on how to perform liquidity stress tests. The paper aims to fill this gap by providing a framework for liquidity stress testing for funds that could be used by regulators or market participants. The working paper presents the method used to perform liquidity stress tests; provides some outcome of the liquidity stress tests for a sample of bond funds; and discusses the related policy implications.

The paper notes that the objective of the liquidity stress test is to assess the resilience of investment funds—at the individual level or at the industry level—to severe, but plausible, redemption shocks. The approach is flexible enough to cope with different methodological assumptions and different degrees of data availability. The framework focuses on the resilience of individual funds or group of funds. Further efforts are needed to integrate the current framework in financial stability analyses. The future work could focus on the design of stress tests for funds, along the lines of modeling joint liquidity and market shocks; on considering the absorbing capacity of markets; and including fire sales. Additional work on data gaps is also warranted, in particular regarding bank-fund inter-linkages. Finally, more exploratory work on integrating further bank-fund inter-linkages would be required to perform system-wide stress tests, as recently recommended by FSB.


Related Link: Working Paper (PDF)

Keywords: International, Banking, Liquidity Stress Testing, Investment Funds, Working Paper, IMF

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