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

A bank's EWI dashboard shows all internal indicators green, yet the market is experiencing widening credit spreads across the sector and falling peer equity prices. What is the most appropriate conclusion?

The divergence should be investigated. Internal and market indicators capture different signals, and sector-wide stress can reach a bank before its own metrics deteriorate. Ignoring market signals because internal ones are green, or discarding internal ones, would reduce the framework's ability to give early warning.

  1. ABecause internal indicators are green, market indicators can be disregarded
  2. BThe bank should discard internal indicators in favour of market indicators only
  3. CInternal and market indicators capture different signals, so the divergence should be investigated rather than dismissedCorrect
  4. DMarket indicators are lagging and therefore irrelevant

Explanation

Effective frameworks combine bank-specific (internal) and market-wide (external) indicators because they capture different vulnerabilities. A divergence signals possible contagion or hidden vulnerability that warrants investigation. Dismissing either set loses information.

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