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FRM Part I · FRM Exam Part I · Enterprise Risk Management and Future Trends

A bank's board wants to translate its overall willingness to take risk into limits that business heads can apply in daily decisions. Which sequence best reflects how a risk appetite framework is normally cascaded?

The board approves a risk appetite statement, and management then cascades it into risk limits and tolerances for business units and desks. Appetite is set top-down in line with strategy and capital capacity, so limits follow from it rather than being built up from desk decisions.

  1. ABoard approves a risk appetite statement, which is converted into risk limits and tolerances at business-unit and desk levelCorrect
  2. BDesk heads set their own limits, which management then aggregates into a statement for board ratification
  3. CRegulators set the limits for each desk, and the board then writes a statement to match them
  4. DBusiness units set targets for return, and risk limits are derived only after losses occur

Explanation

Risk appetite is set top-down: the board approves an appetite statement reflecting strategy and capital capacity, and management converts it into limits and tolerances for business lines and desks. The second option reverses the flow, which would let risk-taking drive appetite rather than the reverse.

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