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

A bank's treasury team is designing an early warning indicator (EWI) framework for liquidity risk. Which description best captures the primary purpose of an EWI?

An early warning indicator is meant to flag rising liquidity vulnerability before it fully materializes. This gives management time to escalate, adjust funding, or activate contingency plans. It is forward-looking, whereas measures that only confirm losses after the event are lagging and do not serve this purpose.

  1. ATo signal a potential increase in liquidity risk exposure or vulnerability before it fully materializes, so management can act in timeCorrect
  2. BTo confirm after the event that a liquidity crisis has occurred and to measure its final cost
  3. CTo replace the regulatory liquidity coverage ratio with an internal measure
  4. DTo set the bank's long-term funding strategy for the next five years

Explanation

EWIs are forward-looking signals that point to emerging vulnerabilities, which lets management trigger contingency actions early. Option B describes a lagging measure. EWIs complement rather than replace regulatory metrics, and they do not set funding strategy.

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