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FRM Part II · FRM Exam Part II · Liquidity and Reserves Management: Strategies and Policies

A mid-sized bank observes the following over two weeks: its five-year CDS spread widens sharply, retail deposit outflows rise above their historical range, and its equity price falls 18% relative to peers. No funding has yet failed to roll. How should these be classified within its contingency funding framework?

These are early warning indicators. Widening CDS spreads, abnormal deposit outflows and relative equity underperformance signal emerging liquidity stress before funding actually fails, so they should trigger heightened monitoring and the escalation steps defined in the contingency funding plan.

  1. ALagging indicators that confirm a liquidity crisis has already occurred
  2. BEarly warning indicators that should trigger heightened monitoring and possible CFP activation stepsCorrect
  3. CIrrelevant to liquidity because the bank has met all maturing obligations
  4. DCapital adequacy indicators that belong only in the ICAAP

Explanation

CDS widening, deposit outflow acceleration and relative equity underperformance are classic market and behavioral EWIs signalling potential stress before funding fails. They should prompt escalation per the CFP. Meeting obligations so far does not make them irrelevant.

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