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

Which feature most improves the usefulness of an early warning indicator framework for liquidity risk?

Combining internal, bank-specific indicators with external market-wide indicators, each tied to predefined escalation actions, makes the framework most useful. It captures both idiosyncratic and systemic stress early, and clear thresholds ensure management responds before a regulatory breach rather than after.

  1. ACombining internal bank-specific indicators with external market-wide indicators, each tied to predefined escalation actionsCorrect
  2. BRelying exclusively on indicators published annually in financial statements
  3. CUsing only a single composite metric with no defined thresholds
  4. DSetting thresholds only at the level of a regulatory breach

Explanation

Effective frameworks blend bank-specific signals (such as deposit trends) with market signals (such as spreads and CDS levels), and link thresholds to actions. Annual or threshold-free metrics are too slow, and thresholds at breach level leave no time to act.

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