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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 design feature best allows the indicators to function as early warnings rather than as lagging confirmations of stress?

Indicators should capture shifts in funding conditions that precede realised stress, such as spreads or deposit behaviour, so management can act early. Annual audited data or thresholds breached only after contingency plans are drawn are lagging, and a single composite metric hides what is deteriorating.

  1. ASelecting metrics that capture changes in funding conditions before they appear in the liquidity coverage ratio or reported outflowsCorrect
  2. BUsing only metrics that are computed from audited year-end financial statements
  3. CSetting thresholds so wide that the indicator is breached only after the bank has drawn on its contingency funding plan
  4. DLimiting the framework to a single composite metric to keep reporting simple

Explanation

An EWI is valuable because it moves ahead of realised liquidity strain, such as widening funding spreads or shortening deposit tenors. Audited year-end data and thresholds breached only after the CFP is activated are lagging. A single composite metric can hide the source of deterioration.

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