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

A bank's treasury team tracks an early warning indicator (EWI) dashboard for liquidity risk. The Chief Risk Officer asks why the dashboard includes both internal indicators (such as deposit outflow rates) and external indicators (such as sovereign CDS spreads). Which is the best justification?

The best justification is that internal indicators reveal bank-specific vulnerabilities, while external indicators reveal market-wide or systemic stress. Using both gives wider coverage of potential liquidity stress sources. Neither type replaces stress testing, contingency funding plans, thresholds or escalation procedures.

  1. AExternal indicators are always more accurate than internal indicators, so internal ones are kept only for regulatory reporting
  2. BInternal indicators capture bank-specific vulnerabilities while external indicators capture market-wide or systemic stress, so together they give broader coverageCorrect
  3. CInternal indicators replace the need for stress testing, while external indicators replace contingency funding plans
  4. DUsing both types removes the need to set thresholds or escalation procedures

Explanation

Internal indicators reflect the bank's own funding and asset quality conditions, while external indicators reflect market or systemic conditions. Combining them provides wider coverage of possible liquidity stress sources. The other options claim substitution or accuracy that the indicators do not provide.

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