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FRM Part II · FRM Exam Part II · Integrated Risk Management

In a bank's ERM framework, the risk appetite statement is being cascaded. Which sequence best reflects how risk appetite, risk limits and risk monitoring should relate?

The board approves risk appetite first, which sets aggregate tolerance. Management then translates it into limits by risk type and business unit and monitors them, escalating breaches. Building appetite from business-unit limits reverses this top-down logic and weakens board oversight.

  1. ALimits are set first by business units, and the board then derives appetite from the sum of limits
  2. BBoard-approved appetite defines aggregate tolerance, which is translated into limits by risk type and business unit, with monitoring and escalation of breachesCorrect
  3. CMonitoring is performed only after year-end, with appetite revised to match actual results
  4. DAppetite is set by the risk function alone and is not communicated to business units

Explanation

Under ERM, the board sets risk appetite top-down. This is then cascaded into limits by risk type and unit, and monitored with breach escalation. Deriving appetite from the sum of limits reverses the logic, which makes the first option the key distractor.

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