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FRM Part II · FRM Exam Part II · Stress Testing Banks

A bank's board has approved a stress testing framework. Senior management proposes that the business lines that own the portfolios being tested should alone choose scenario severity and sign off on results, so that the scenarios are realistic. Which response best reflects sound governance practice for stress testing?

Good governance needs board and senior management oversight, independent risk involvement and effective challenge of scenarios and results. Letting business lines alone set severity creates incentive conflicts, while audit should review rather than own the program, and regulatory-only scenarios miss bank-specific vulnerabilities.

  1. AAccept the proposal, since business lines know their risks best
  2. BRequire that scenario design involve independent risk functions and senior management challenge, with board oversight of the program and its use in decisionsCorrect
  3. CDelegate scenario approval entirely to the internal audit function
  4. DLimit stress testing to regulatory scenarios so no internal judgment is needed

Explanation

Sound governance requires board and senior management oversight, clear responsibilities, and independent challenge of scenarios and results so that business-line incentives do not dilute severity. Audit reviews the process but should not own it. Using only regulatory scenarios ignores bank-specific vulnerabilities.

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