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FRM Part II · FRM Exam Part II · Risk Capital Attribution and Risk-Adjusted Performance Measurement

A bank pays business-line bonuses on RAROC calculated with capital allocated at the start of the year. Managers can influence the capital figure by shifting positions late in the year. Which governance measure best addresses this implementation concern?

The bank should base allocated capital on average or independently validated risk measures produced by a function separate from the business lines. This removes managers' ability to manipulate positions or inputs near the measurement date and keeps RAROC-based bonuses aligned with the actual risk taken.

  1. ABase capital on average or independently validated risk measures produced by a function separate from the business linesCorrect
  2. BAllow business lines to set their own capital estimates for greater accuracy
  3. CReplace capital with revenue as the performance denominator
  4. DUse only stand-alone capital so that diversification is ignored

Explanation

Gaming arises when those being measured control the inputs or timing. Using averaged exposures and independent validation by risk management removes the incentive and the ability to manipulate. Letting units set their own estimates worsens the conflict, and revenue ignores risk altogether.

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