Skip to content

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

A bank's compensation scheme pays traders a large annual cash bonus based on that year's trading revenue, with no clawback or deferral. From a governance perspective drawn from the lessons of the financial crisis, which reform best addresses the main flaw?

Deferring a significant part of pay, linking it to risk-adjusted performance over several years, and allowing clawback best fixes the flaw. It aligns trader incentives with long-term firm health instead of rewarding short-term revenue that may hide tail risks which materialize later.

  1. AIncrease the bonus pool so that talent is retained during downturns
  2. BBase the bonus on revenue measured over a shorter period, such as monthly
  3. CDefer a significant portion of pay, tie it to risk-adjusted performance over a multi-year horizon, and allow clawbackCorrect
  4. DReplace all variable pay with fixed salary for only the risk management staff

Explanation

The flaw is incentive for short-term, risk-ignoring revenue. Deferral, risk adjustment and clawback align pay with long-term outcomes. A shorter measurement period worsens short-termism, and larger bonuses do not fix the misalignment.

Did you get it right without looking?

One question tells you little. A timed set on The Governance of Risk Management shows your real accuracy, how long you take and where you lose marks.

Practise The Governance of Risk ManagementFree diagnostic mock

More The Governance of Risk Management questions