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FRM Part II · FRM Exam Part II · Contingency Funding Planning

Which of the following is the best example of an external early warning indicator of a potential institution-specific liquidity stress event?

A widening CDS spread relative to peers, together with a falling share price, is an external early warning indicator because it shows market participants are losing confidence in the bank. The other choices are internal metrics or, in the case of more insured deposits, a stabilizing factor.

  1. AA rise in the bank's overnight unsecured borrowing from its own subsidiaries
  2. BA decline in the average maturity of the bank's internal funds transfer pricing curve
  3. CA widening of the bank's five-year CDS spread relative to peer banks, combined with a falling share priceCorrect
  4. DAn increase in the share of retail deposits covered by deposit insurance

Explanation

External indicators reflect market perception of the bank: CDS spreads relative to peers and equity price declines signal eroding counterparty confidence and potential funding withdrawal. The other options are internal measures; an increase in insured deposits would actually be a stabilizing factor.

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