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

A treasury team at a mid-sized bank is designing its liquidity monitoring framework. Which description best captures the purpose of an early warning indicator (EWI) in liquidity risk management?

An early warning indicator is a forward-looking metric that flags emerging liquidity vulnerabilities, so management can escalate and act before a stress event fully develops. It is not a regulatory minimum, a post-event shortfall report, or a transfer pricing tool.

  1. AA metric that signals emerging vulnerabilities so management can act before a liquidity stress event fully developsCorrect
  2. BA regulatory ratio that sets the minimum stock of high-quality liquid assets the bank must hold at all times
  3. CA backward-looking measure that reports the actual cash shortfall after a funding crisis has occurred
  4. DA pricing tool that allocates the cost of liquidity to business lines

Explanation

EWIs are forward-looking signals of rising liquidity risk or vulnerability, used to trigger escalation and contingency actions before stress crystallises. A regulatory ratio sets a standing minimum, not a signal. Backward-looking shortfall reports and transfer pricing serve different purposes.

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