FRM Part II · FRM Exam Part II · Governance
A bank observes that, in a benign credit cycle, loan officers are being rewarded on origination volume and the share of approvals granted as policy exceptions has risen from 3% to 11% over two years. Which governance response best addresses the root cause?
The best response is to align incentives with risk-adjusted results and loan quality, and have independent credit risk report exception trends to the board risk committee. Volume-based pay is driving looser underwriting; changing limits or hiding exceptions would only conceal the weakening of standards.
- ARaise the single-name exposure limits so fewer approvals count as exceptions
- BRebalance incentives to include risk-adjusted performance and loan quality, and have independent credit risk report exception trends to the board risk committeeCorrect
- CMove all approvals to the front-line business to speed up decisions
- DStop recording exceptions to avoid signaling weak standards
Explanation
Rising exceptions alongside volume-based pay indicate an incentive conflict that erodes underwriting discipline. The fix is aligned compensation and independent monitoring with board-level reporting. Raising limits or hiding exceptions masks the problem.
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