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

A bank's liquidity committee reviews its EWI dashboard. Over six weeks, the share of deposits above the insured limit rose from 30% to 42%, the loan-to-deposit ratio rose from 88% to 97%, and the bank's CDS spread widened 60 bps while peers' spreads were unchanged. No indicator has breached its red trigger. Which response is most consistent with sound EWI practice?

Management should escalate and consider pre-emptive actions such as lengthening funding tenor, because multiple bank-specific indicators are worsening together. EWIs are meant to prompt action before hard limits are breached, so waiting for a red trigger, dropping indicators or resetting thresholds would defeat their purpose.

  1. ATake no action until at least one indicator breaches its red trigger, to avoid false alarms
  2. BEscalate to senior management and consider pre-emptive steps such as extending funding tenor, because the combined trend signals building vulnerabilityCorrect
  3. CRemove the CDS indicator from the dashboard since it is a market-based measure and noisy
  4. DReplace the triggers with a single composite threshold set at the current levels to avoid further alerts

Explanation

Several bank-specific indicators are deteriorating together, including a rise in uninsured deposits (run-prone), higher loan-to-deposit ratio and idiosyncratic CDS widening. EWIs exist to prompt action before red triggers; waiting defeats their purpose. Dropping indicators or resetting thresholds hides the signal.

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