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

A bank's treasury team is designing early warning indicators (EWIs) for liquidity risk. Which feature most clearly distinguishes a useful EWI from a lagging liquidity metric such as the current liquidity coverage ratio?

A useful early warning indicator signals deterioration before the bank's liquidity position is materially affected, giving management time to respond. Lagging metrics only describe the position after the change has happened, so they provide less opportunity for preventive action.

  1. AIt signals deterioration in conditions before the bank's liquidity position is materially affectedCorrect
  2. BIt is reported only to regulators and not to senior management
  3. CIt is calculated exclusively from audited financial statements
  4. DIt is based solely on the bank's own credit rating

Explanation

An EWI is meant to be forward-looking and to flag emerging vulnerabilities before they hit the liquidity position, giving time to act. Lagging metrics describe the position after changes have occurred. Restricting reporting, relying on audited data or using only the rating do not define an EWI.

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