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FRM Part I · FRM Exam Part I · Learning From Financial Disasters

A bank's fixed-income desk has a single head who sets traders' bonuses, approves limit exceptions and signs off valuation marks for illiquid positions, while risk reporting to the board goes through that same head. Which assessment is most consistent with lessons from rogue-trading cases such as Barings, Kerviel and UBS?

This structure is a weakness because one person controls pay, limit exceptions, valuation and board reporting, removing independent challenge. Rogue-trading cases show such concentration allows mismarking and concealment. Daily VaR does not fix it, since the inputs and reports remain under the business line's control.

  1. AThe concentration of authority and reporting lines weakens independent challenge and creates an opportunity for mismarking and concealmentCorrect
  2. BThe structure is efficient and reduces operational risk because decisions are centralized
  3. CThe main issue is that bonuses are too low to motivate truthful reporting
  4. DThe structure is acceptable provided VaR is calculated daily

Explanation

Rogue-trading cases show losses persist when the business controls pay, limits, valuation and reporting. Independent risk, finance and valuation control functions must challenge the desk. Daily VaR does not cure the lack of independence because inputs can be influenced.

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