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FRM Part I · FRM Exam Part I · The Governance of Risk Management

A bank's board risk committee reviews a proposal for a new structured product line. The committee notes that the business head is the sole approver of the valuation model, the product's profits drive his bonus, and the risk function only receives results after trades are booked. Which single change would most directly remedy the governance gap highlighted by crisis experience?

Independent validation and approval of the model and new-product risks by the risk function before trading, with escalation rights to the board, best fixes the gap. It removes the business head's conflict of interest and provides challenge before exposures are created, not afterward.

  1. ARequire independent validation and approval of the valuation model and new-product risks by the risk function before trading begins, with escalation rights to the boardCorrect
  2. BAsk the business head to certify the model annually in writing
  3. CIncrease the frequency of profit reporting from the business to monthly
  4. DHave the internal audit team recompute the profits after year end only

Explanation

The gap is conflict of interest and lack of ex-ante independent challenge. Independent pre-trade validation with escalation addresses both. Self-certification retains the conflict, more frequent profit reports ignore risk, and year-end audit is after the fact.

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