FRM Part II · FRM Exam Part II · Governance
A bank pays loan originators a bonus based solely on the volume of loans booked in the year, paid in full in cash immediately. Which governance concern is most directly raised, and which remedy is most consistent with sound compensation practice?
The scheme encourages excessive risk-taking because it rewards volume and pays immediately while credit losses appear later. The remedy is to tie compensation to risk-adjusted performance, defer part of it over the loan's performance horizon, and permit clawback if losses emerge.
- AExcessive risk-taking incentives; align pay with risk-adjusted performance and defer part of it with clawbackCorrect
- BInsufficient incentives; increase the cash bonus to attract talent
- CPoor liquidity; require originators to hold loans for sale
- DModel risk; require originators to build their own PD models
Explanation
Volume-based, immediate pay rewards originating risky loans whose losses emerge later, creating a short-term bias. Sound practice links pay to risk-adjusted outcomes, defers a portion, and allows malus or clawback. The other options do not address the incentive misalignment.
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