FRM Part II · FRM Exam Part II · Risk Governance
A bank's board is reviewing its operational risk framework. Which statement best describes the relationship between risk appetite and risk tolerance (risk limits) in a sound governance structure?
Risk appetite is the aggregate amount and type of risk a firm is willing to take to meet its objectives, set at board level. Risk tolerances convert that appetite into specific, measurable boundaries for business lines or risk types, so they operationalise the appetite.
- ARisk appetite is the aggregate level and type of risk the firm is willing to assume to achieve its objectives, while risk tolerances translate that appetite into more specific, measurable boundaries for business lines or risk typesCorrect
- BRisk tolerance is set by the board for the whole firm, while risk appetite is set by individual business line managers for their own activities
- CRisk appetite and risk tolerance are interchangeable terms and should always be set at the same numerical level
- DRisk tolerance is a qualitative statement of culture, while risk appetite must be expressed only as a single capital ratio
Explanation
Risk appetite is the broad, board-approved amount and type of risk the firm will accept to pursue its strategy. Tolerances are narrower, quantified boundaries that operationalise the appetite for units or risk types. The other options reverse ownership, equate the terms, or wrongly restrict the form of each.
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