FRM Part II · FRM Exam Part II · Governance
A bank's head of compensation proposes a new bonus scheme for loan originators. Which design feature best aligns incentives with the bank's long-term credit risk profile?
Deferring part of the bonus over several years, paying some in equity, and allowing clawback if loans perform poorly links pay to realized long-term credit outcomes. Immediate cash tied to volume or unadjusted revenue, or guaranteed bonuses, rewards risk-taking without accountability for later losses.
- ABonus paid fully in cash at origination, based on volume of loans booked in the year
- BA portion of bonus deferred over several years, paid partly in equity, and subject to clawback if loan performance deterioratesCorrect
- CBonus based on the revenue of the originator's desk, with no adjustment for expected losses
- DA fixed bonus pool that is guaranteed for the first two years regardless of performance
Explanation
Deferral, equity-linked payment and clawback tie pay to the realized risk outcome of loans over time. Volume- or revenue-based immediate cash rewards risk-taking without regard to later losses, and guaranteed bonuses remove the performance link altogether.
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