FRM Part II · FRM Exam Part II · Governance
A bank's relationship managers earn bonuses based on loan volume booked and also approve the internal risk ratings of their own borrowers. Which governance weakness does this arrangement most directly create?
The arrangement creates a conflict of interest. Relationship managers paid on volume have an incentive to give borrowers favourable ratings, so sound governance requires independence between origination and credit risk assessment, with ratings assigned or reviewed by a function not rewarded for loan growth.
- AExcessive reliance on external ratings
- BA conflict of interest from lack of independence between origination and credit risk assessmentCorrect
- CInsufficient diversification of the loan portfolio by sector
- DOver-centralisation of credit approval authority
Explanation
Origination staff paid on volume have an incentive to assign favourable ratings. Sound governance separates rating assignment and validation from business-line incentives. The other options describe different issues not indicated by the facts.
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