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Answer: Rapid growth in the leverage ratio with significant dependence on short-term repo financing
C is correct. Rapid levered asset growth combined with substantial use of short-term repos is an early warning of a potential liquidity problem. Decreased collateral haircuts, a credit rating upgrade, and increased asset diversification are generally positive developments and not early warnings of a potential liquidity problem.
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The Basel Committee recommends that financial institutions utilize a range of early warning indicators to detect emerging risks and possible weaknesses in their liquidity status. This proactive approach helps institutions to identify and mitigate potential liquidity crises before they escalate. Considering this advisory, which of the following options is considered an early warning sign of a potential liquidity issue?
A
Credit rating upgrade
B
Increased asset diversification
C
Rapid growth in the leverage ratio with significant dependence on short-term repo financing
D
Decreased collateral haircuts applied to the bank's collateralized exposures