FRM Part II · FRM Exam Part II · Risk Governance
A bank's board is reviewing its risk appetite framework. Which statement best describes the relationship between risk appetite, risk tolerance and risk limits in a well-designed operational risk governance structure?
Risk appetite is the aggregate amount and type of risk a firm is willing to accept to achieve its objectives, set at board level. Limits and tolerances translate that appetite into measurable operational thresholds for business units, which creates a cascade from strategy to day-to-day management.
- ARisk limits are set by the board, while risk appetite is set by business line managers based on their daily activities
- BRisk appetite is the aggregate level and types of risk the firm is willing to accept to achieve its objectives, while limits translate appetite into operational thresholds for business unitsCorrect
- CRisk tolerance is always set higher than risk appetite so that management has no need to escalate breaches
- DRisk appetite and risk limits are identical concepts and differ only in the department that monitors them
Explanation
Risk appetite is a board-level statement of the amount and type of risk the firm will accept to pursue its strategy. Tolerance and limits cascade this into measurable thresholds that business units can manage against. Setting limits at the board level while appetite sits with business lines reverses the governance hierarchy.
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