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FRM Part II · FRM Exam Part II · Risk Measurement and Assessment

A bank's loss database records a loan fraud as follows: an employee colluded with an outside borrower to approve a false loan, causing a loss, and the bank also lost money because credit analysis was not performed. A risk manager wants to avoid double counting between credit and operational risk. Which treatment is most consistent with common industry practice?

The loss should be recorded as operational risk, specifically internal fraud, with a flag showing its credit-related nature. This follows the cause-based approach to boundary events and prevents duplicate capital, whereas booking it in both categories double counts and excluding it hides a real loss.

  1. ARecord the loss in both credit and operational risk loss databases and add the capital for each
  2. BRecord it only as credit risk because the loss arose from a loan default
  3. CRecord it as operational risk (internal fraud) and flag it as credit-related for boundary reporting, avoiding duplicate capitalCorrect
  4. DExclude it from both databases because collusion losses are unpredictable

Explanation

Boundary events caused by fraud or process failure are treated as operational risk losses, since the cause is the operational failure, and flagged as credit-related so the exposure is not counted twice in capital. Adding capital in both categories double counts, and excluding it ignores a genuine loss.

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