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

A bank's operational risk team is building a risk taxonomy. It wants categories that are mutually exclusive and collectively exhaustive so that each loss event is classified in exactly one place. Which approach best supports this goal for classifying loss events?

Classifying each event by a single primary root cause with clear definitions best supports a mutually exclusive and exhaustive taxonomy. Multiple tagging causes double counting, ledger location reflects accounting, and loss size is an outcome rather than a risk category, so they do not give clean classification.

  1. AClassify each event by the business line where the loss was booked in the general ledger
  2. BClassify each event by its root cause, using a single primary cause category defined with clear criteriaCorrect
  3. CAllow each event to be recorded in every category that it touches to avoid omissions
  4. DClassify each event by the size of the loss so that large events are grouped together

Explanation

A taxonomy that is mutually exclusive needs clear criteria and a single primary classification, commonly by cause or event type. Classifying by multiple categories creates double counting, ledger booking location reflects accounting rather than risk, and loss size is an outcome, not a risk category.

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