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

A bank's treasury team tracks a set of early warning indicators (EWIs) for liquidity risk. The Chief Risk Officer asks why the indicators should be reviewed and recalibrated at regular intervals rather than fixed once. Which is the best reason?

Indicators should be reviewed regularly because the link between an indicator and liquidity stress changes as the bank's business model, funding mix and market conditions evolve. Stale thresholds can give false comfort or false alarms, and review does not remove the need for management judgment.

  1. ARelationships between indicators and liquidity stress can change as the business model, funding mix and market conditions changeCorrect
  2. BRegulators require every indicator threshold to be tightened each year
  3. CIndicators lose all predictive value after a single stress event
  4. DRecalibration removes the need for management judgment when an indicator is breached

Explanation

Indicators are useful only while they reflect the bank's current risk profile and market environment. Business mix, funding sources and market structure evolve, so thresholds and indicator sets need periodic review. The other options overstate or invent requirements, and recalibration never replaces judgment.

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