FRM Part II · FRM Exam Part II · Risk Governance
A bank's board sets a risk appetite statement that annual operational losses should not exceed 5% of annual pre-provision net revenue. The bank has an early-warning trigger at 60% of that level and a hard limit at 100%. Pre-provision net revenue is expected to be USD 800 million. Operational losses year-to-date are USD 27 million. What is the appropriate conclusion?
The loss limit is 5% of USD 800 million, or USD 40 million, and the early-warning trigger is 60% of that, USD 24 million. Year-to-date losses of USD 27 million exceed the trigger but not the limit, so the breach must be escalated.
- AThe hard limit is USD 40 million and the trigger of USD 24 million has been breached, so escalation is neededCorrect
- BThe hard limit is USD 40 million and no trigger has been breached, so no action is needed
- CThe hard limit is USD 27 million and has just been reached
- DThe hard limit is USD 48 million and the trigger of USD 28.8 million has not yet been breached
Explanation
Limit = 5% x 800 = USD 40 million. Trigger = 60% x 40 = USD 24 million. Losses of USD 27 million exceed the trigger but are below the limit, so escalation is warranted. Option D wrongly uses 6% of revenue as the limit.
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