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FRM Part II · FRM Exam Part II · Governance

A bank's relationship managers have proposed raising the internal rating of a long-standing client, which would reduce capital charges and increase the manager's bonus. The chief risk officer wants to preserve the independence required by the three lines model. Which arrangement best achieves this?

Rating changes should be validated and approved by an independent credit risk function whose pay is not tied to the loan's revenue. This removes the conflict of interest present in the first line, while internal audit stays independent to review the process afterward.

  1. ARating changes are validated and approved by an independent credit risk function not compensated on the loan's revenueCorrect
  2. BRelationship managers assign ratings and internal audit approves them before each year-end
  3. CRating changes are approved by the head of the business line, who has the best client knowledge
  4. DRating changes are decided by a committee chaired by the relationship manager's direct supervisor

Explanation

Independence requires that those assigning or approving ratings are not rewarded by the revenue of the exposure, which is a second-line role. Internal audit approving ratings would compromise the third line's independence, and business-line approval retains the conflict of interest.

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