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FRM Part II · FRM Exam Part II · Risk Identification

In an RCSA, a payments unit rates the inherent risk of settlement errors as 'High'. After evaluating the controls, which are judged 'Strong', the unit reports a residual risk of 'Low'. Which statement best describes the relationship being applied?

Residual risk is what remains after the effect of existing controls is applied to inherent risk. Here, high inherent settlement risk combined with strong controls yields low residual risk. Residual risk is not the pre-control exposure and is not defined by audit detection or recorded losses.

  1. AResidual risk is the risk remaining after considering the effect of existing controls on inherent riskCorrect
  2. BResidual risk is the risk before any controls, so it must always be higher than inherent risk
  3. CResidual risk equals inherent risk multiplied by the probability of audit detection
  4. DResidual risk measures only losses that have already been recorded in the loss database

Explanation

Inherent risk is the exposure absent controls; residual risk is what remains after controls are taken into account. Strong controls reduce it. The other options reverse the definition or confuse it with loss data.

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