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FRM Part II · FRM Exam Part II · Sound Management of Risks Related to Money Laundering and Financing of Terrorism

A bank scores each of four business lines on inherent ML/FT risk (1-5) and control effectiveness (reduction of inherent risk: Strong 60%, Adequate 40%, Weak 20%). Residual risk = inherent score x (1 - reduction). Private Banking: inherent 5, Adequate. Retail: inherent 3, Strong. Correspondent Banking: inherent 4, Weak. Trade Finance: inherent 4, Adequate. Which business line has the highest residual risk, and what is it?

Correspondent Banking has the highest residual risk at 3.2, from an inherent score of 4 multiplied by 0.8 because weak controls reduce risk only 20%. Private Banking has higher inherent risk but its adequate controls give 3.0, Trade Finance 2.4 and Retail 1.2.

  1. APrivate Banking, 3.0
  2. BCorrespondent Banking, 3.2Correct
  3. CTrade Finance, 2.4
  4. DRetail, 1.2

Explanation

Private Banking: 5 x 0.6 = 3.0. Retail: 3 x 0.4 = 1.2. Correspondent Banking: 4 x 0.8 = 3.2. Trade Finance: 4 x 0.6 = 2.4. Correspondent Banking is highest at 3.2; Private Banking has the highest inherent risk but stronger controls.

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