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FRM Part II · FRM Exam Part II · Risk Governance

A bank sets a risk appetite of operational losses not exceeding 5% of annual gross income. Gross income is USD 2.0 billion. Tolerance is set at 120% of appetite, and the hard limit at 150% of appetite. The bank's losses for the year are USD 115 million, with a further USD 20 million loss event under investigation likely to be confirmed. What is the correct status once the event is confirmed?

Appetite is USD 100 million, tolerance 120 million and the hard limit 150 million. Confirmed losses of 135 million exceed tolerance but remain below the hard limit, so the bank is beyond tolerance and must escalate and remediate, though it has not breached the maximum limit.

  1. AWithin appetite, since 115 million is above 100 million but below tolerance
  2. BBeyond tolerance but within the hard limit, since total losses of 135 million exceed 120 million tolerance but are below 150 millionCorrect
  3. CBeyond the hard limit, since total losses exceed 5% of income
  4. DWithin tolerance, since 135 million is less than 150 million

Explanation

Appetite = 5% x 2,000 = USD 100m; tolerance = 120m; hard limit = 150m. Current losses of 115m are above appetite but under tolerance. Adding 20m gives 135m, which is above tolerance (120m) but below the hard limit (150m). Calling it within tolerance confuses tolerance with the hard limit.

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