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FRM Part II · FRM Exam Part II · Early Warning Indicators

A bank tracks three early warning indicators, each with a red threshold. Deposit outflow: 2.0% of retail deposits per week (red at 3%). Cost of 3-month unsecured funding over the benchmark: 40 bps (red at 60 bps). Share of encumbered assets: 28% (red at 25%). The head of treasury also notes that the funding spread rose from 25 bps to 40 bps in two weeks. Which conclusion is best supported?

Only the encumbrance indicator, at 28% against a 25% threshold, is in red. Deposit outflows and the funding spread remain below their red levels, but the 15 bp spread widening in two weeks is an adverse trend that merits close monitoring, since indicators should be read for both level and direction.

  1. AOnly the encumbrance indicator is in red, but the rapid spread widening shows a worsening trend that warrants close monitoring even though it is below its thresholdCorrect
  2. BAll three indicators are in red and the contingency funding plan must be fully invoked
  3. CNo indicator is in red, so the trend in spreads can be ignored
  4. DThe deposit outflow is in red because 2.0% is above the average outflow

Explanation

Encumbrance at 28% exceeds its 25% red threshold. Outflows (2% vs 3%) and spread (40 vs 60 bps) are below red. The spread moved by 15 bps in two weeks, so the trend matters. Good practice considers both levels and rates of change.

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