FRM Part II · FRM Exam Part II · Governance
During a credit boom, a bank's loan officers are paid bonuses based on origination volume, and the bank grants frequent policy exceptions to win business. Which governance response is most effective at addressing the underlying weakness in underwriting standards?
Aligning compensation with risk-adjusted, through-the-cycle loan performance and requiring independent approval and reporting of policy exceptions addresses both the incentive problem and the erosion of standards. Uniform price rises, reduced credit review or self-approved exceptions would not resolve the root cause.
- ALink incentives to risk-adjusted and through-the-cycle loan performance, and require independent reporting and approval of exceptionsCorrect
- BRaise all loan prices uniformly by 50 basis points
- CReduce the number of staff in the independent credit review function to cut costs
- DAllow originators to approve their own exceptions to speed up decisions
Explanation
The weakness is misaligned incentives and weak exception control. Tying pay to loan quality and independently monitoring exceptions addresses both. Uniform price increases do not fix standards, and weakening independence or letting originators self-approve worsens the problem.
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