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FRM Part I · FRM Exam Part I · Enterprise Risk Management and Future Trends

A bank's risk committee is reviewing how best to identify emerging risks such as those arising from climate change and rapid technological change. Which approach is most consistent with good practice for emerging risk identification?

Emerging risks should be identified with forward-looking tools such as scenario analysis and horizon scanning, using diverse internal and external expertise. Historical loss data and VaR cannot capture risks that have no track record, and restricting review to quantifiable risks would ignore the most uncertain, new exposures.

  1. ARelying solely on historical loss data and backward-looking VaR models to detect new risks
  2. BUsing forward-looking tools such as scenario analysis and horizon scanning, with input from diverse business and external expertsCorrect
  3. CDelegating emerging risk identification entirely to the internal audit function once a year
  4. DLimiting the review to risks that can already be quantified with a reliable probability distribution

Explanation

Emerging risks are by nature new and lack historical data, so forward-looking tools such as scenario analysis and horizon scanning, informed by varied perspectives, are preferred. Historical data and VaR cannot capture risks with no loss history. Restricting attention to quantifiable risks excludes precisely the uncertain ones that matter.

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