This is a very badly worded question (though I’m not English).
Based on the answers given in the curriculum, I guess for question B they wanted to say “lift credit standards” instead of “increase credit standards”.
For the liquidity: if they don’t hold mortgage loans, they need less liquidity because mortgage loans are prepayable by the borrowers. Most probably they will offer loans with no early repayment option instead.
Increasing the credit standards means borrowers need a higher credit rating to qualify for a loan. This will decrease the banks provisions for credit losses as they’re loaning money to better qualified applicants.
if their overall risk appetite hasn’t changed, and they’ve now reduced the risk of credit loss by increasing the lending standards, they can pick up the lost risk by investing in below investment grade securities.