Early Warning Indicators: formula sheet

Key formulas

Indicator breach test

Breach if indicator value ≥ threshold (or ≤ threshold for falling measures)

Direction matters. Outflows, spreads and concentration breach when they rise. Buffers and ratings breach when they fall.

Deposit outflow rate

Outflow rate = deposits withdrawn ÷ opening deposits

Compare with the trigger over a stated period, such as one day or one week.

Wholesale funding reliance

Reliance = short-term wholesale funding ÷ total funding

A rising ratio signals greater run risk.

Escalation logic

Indicator → threshold → trigger → CFP stage → action

Use this chain to structure any case answer.

Internal (bank-specific) indicators

Source = bank's own data: funding concentration, deposit outflows, maturity shortening, buffer decline, rising reliance on wholesale funding

Observed directly by the bank, usually daily or weekly. Often the earliest signal.

External (market-wide) indicators

Source = markets and third parties: CDS spreads, rating changes, equity price declines, bond spreads, interbank and repo conditions

Reflect market perception. Can move fast but may be noisy or lag.

Funding concentration share

Concentration = funding from largest provider (or product) ÷ total funding

A higher share means higher risk if that source withdraws. No universal threshold; the bank sets its own.

Net deposit outflow rate

Outflow rate = (Deposits at start − Deposits at end) ÷ Deposits at start

Compare with the normal range for the period. Unusual size or speed is the warning.

False positive rate

False positive rate = false alarms ÷ (false alarms + correct non-alarms)

Share of calm periods in which the indicator still signalled. Making the threshold less sensitive (later-triggering) reduces it.

False negative rate (miss rate)

Miss rate = missed events ÷ (missed events + signalled events)

Share of real stress events with no prior signal. Equals 1 − hit rate. Making the threshold more sensitive (earlier-triggering) reduces it.

Hit rate (sensitivity)

Hit rate = signalled events ÷ total real events

Making the threshold more sensitive (tighter, earlier-triggering) raises hit rate but usually raises false alarms too.

Threshold from a percentile

Threshold = percentile p of the indicator's historical distribution (e.g. 90th or 95th)

A starting point only. Adjust using stress results and judgment.

Tier rule

Green: below amber level. Amber: amber ≤ value < red. Red: value ≥ red level (for indicators where higher means worse)

Reverse the inequalities for indicators where lower means worse, such as a liquid asset ratio.

Trade-off rule

More sensitive (earlier-triggering) threshold → fewer false negatives, more false positives. Less sensitive threshold → fewer false positives, more false negatives.

Here 'tighter' means more sensitive, not a higher or lower number. The two error types move in opposite directions for a given indicator.

Quick revision

• An EWI signals potential liquidity stress before it appears in reported metrics.
• EWIs are forward-looking; ratios such as LCR and NSFR are not designed as early signals.
• Indicators can be internal (deposit outflows, funding concentration) or external (market spreads, rating actions).
• Funding cost rises, shorter wholesale maturities and falling deposits are typical funding-side warnings.
• Market signals include widening CDS spreads, falling share price and lower market access.
• Each indicator needs a metric, a threshold and a defined trigger action.
• Tiered thresholds let you escalate gradually rather than react all at once.
• Breaches should be escalated to senior management or the ALCO under a set governance process.
• A trigger should link to the contingency funding plan.
• Review indicators regularly and recalibrate after stress events or business changes.
• Limitations: false positives, false negatives, data lags and indicators moving together in a crisis.
• No single indicator is enough; use a dashboard and judgement.

Common mistakes

• Treating EWIs as the same as stress tests. Fix: EWIs monitor current signals. Stress tests project outcomes under scenarios. They complement each other.
• Calling a market signal like CDS spread an internal indicator. Fix: If it comes from market prices or agencies, it is external even when bank-specific.
• Classifying CDS spreads as internal because they refer to the bank. Fix: Classify by data source. CDS spreads are set by the market, so they are external, even if they relate to the bank's own name.
• Treating a rating downgrade as an early signal. Fix: Ratings often lag market and internal signals. A downgrade is still an indicator, and it can trigger further funding loss or collateral calls.
• Swapping false positives and false negatives. Fix: Positive means the indicator signalled. A false positive is a signal with no real stress. A false negative is no signal despite real stress.
• Assuming tightening a threshold cuts both error types. Fix: For one indicator, tightening reduces misses but raises false alarms. Only better indicators or combinations improve both.
• Treating indicators as predictors that guarantee advance warning. Fix: Remember they give probabilistic signals, often with lags. They support judgement and do not replace stress testing.
• Thinking the treasury alone owns the indicator framework. Fix: Board or senior committee approves thresholds and escalation. Risk and independent review also have roles.

Exam tips

• Expect case-style stems: a list of signals, then a question on classification or response.
• Remember the chain: indicator, threshold, trigger, CFP action.
• Watch for options that overstate EWIs as predictive guarantees or as substitutes for stress testing.
• Do the ratio arithmetic carefully and check which tier it falls in.
• Classify by data source, not by who the signal is about. This is the most common test.
• Know at least three examples of each type: internal (funding concentration, deposit outflows, buffer decline) and external (CDS spreads, rating changes, equity price declines).
• Read for words such as bank-specific and market-wide. They tell you which group the question wants.
• When a question asks for the best response, think escalation: monitor, then act, then activate the contingency funding plan.