FRM Part II · FRM Exam Part II · Governance
A relationship manager at a bank is rewarded mainly on loan volume booked, and credit approvals for large exposures are given by a committee that includes the same manager's head of business. Which governance weakness is most evident, and what is the best remedy?
The weakness is a conflict of interest between volume-based incentives and approval authority. The remedy is to separate credit approval from origination, giving risk independent authority, and to tie compensation to risk-adjusted performance, so loan quality rather than volume drives behaviour.
- AModel risk; replace the scoring model
- BConflict of interest in incentives and approvals; separate approval authority from origination and add risk-adjusted performance measures to compensationCorrect
- CLiquidity risk; raise the liquidity buffer
- DConcentration risk; impose a sector cap only
Explanation
Volume-based pay combined with origination-aligned approval creates a conflict of interest that biases credit decisions. The remedy is independence of the approval process (credit officers or risk with veto) and incentives that account for risk and loan quality. Sector caps or model changes do not address the incentive problem.
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