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

A bank's liquidity committee wants an EWI set that gives both early detection and few false alarms. Which design choice is most consistent with good practice?

Good practice combines a range of internal and external indicators, calibrates thresholds to the bank's own risk profile and reviews them regularly. A single hypersensitive indicator causes false alarms, while relying only on regulatory ratios or only on external data leaves important vulnerabilities undetected.

  1. AUse a single indicator with a very low threshold so every possible stress is captured
  2. BCombine a range of internal and external indicators, calibrate thresholds to the bank's risk profile, and review them regularlyCorrect
  3. CRely only on regulatory ratios because they are standardized
  4. DUse only external market indicators because they update daily

Explanation

Good practice uses a diverse set of internal and external indicators, with thresholds tailored to the institution and reviewed over time. A single low threshold generates false alarms, and relying only on regulatory ratios or only external data leaves blind spots.

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