FRM Part II · FRM Exam Part II · Risk Governance
A bank's board approves an operational risk appetite statement that sets annual operational loss tolerance at USD 40 million. Management sets an early-warning trigger at 75% of tolerance. Year-to-date losses are USD 27 million after eight months, and losses are expected to continue at the same monthly rate. What is the most appropriate conclusion?
The trigger is USD 30 million (75% of 40 million). Losses of 27 million over eight months imply 40.5 million for the year, above tolerance. Early-warning triggers exist to prompt escalation before an actual breach, so management should escalate now based on the projected overrun.
- AThe trigger has not been breached yet, and no action is needed because the annual tolerance has not been exceeded
- BThe trigger of USD 30 million is projected to be breached, and the full-year projected loss of USD 40.5 million would exceed tolerance, so escalation is warranted nowCorrect
- CThe tolerance is already breached because losses exceed 66% of the annual limit
- DEscalation is only required once losses exceed USD 40 million, as triggers are not part of governance
Explanation
Trigger = 0.75 x 40 = USD 30m. Monthly rate = 27/8 = 3.375m, so the annual projection = 3.375 x 12 = USD 40.5m, above the USD 40m tolerance. The trigger will be crossed around month nine, so forward-looking escalation is appropriate rather than waiting for an actual breach.
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