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Answer: A model developer is given responsibility for validating the soundness of the model.
## Explanation **B is correct** because this represents a clear conflict of interest. When a model developer is responsible for validating their own model, there is an inherent bias and lack of independence. The developer has a vested interest in the model being approved and may overlook or downplay deficiencies. Proper risk management requires that model validation be conducted by an independent group or internal auditor who can provide objective assessment without conflicts. **A is incorrect** because the CRO overseeing the second line of defense is actually part of proper governance structure. The second line of defense consists of risk management specialists who provide day-to-day oversight, and their supervision by the CRO is standard organizational hierarchy. **C is incorrect** because both responsibilities fall within the normal scope of a senior economist's duties at a regulatory agency. There is no inherent conflict between drafting market reform proposals and advising on trading regulations, as these are complementary regulatory functions. **D is incorrect** because business unit heads petitioning for temporary risk limit increases is a legitimate part of risk management processes. This involves proper escalation procedures through risk committees and does not represent a conflict of interest.
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A risk manager is reviewing the inherent deficiencies that are commonly observed in risk management frameworks and assessing how risk management systems can be compromised by human agency. The manager focuses on cases involving conflicts of interest, which undermine the credibility of a risk management system. Which of the following is the best example of a conflict of interest?
A
The CRO of a bank provides oversight over the second line of defense of the bank.
B
A model developer is given responsibility for validating the soundness of the model.
C
A senior economist at a regulatory agency helps draft a proposal for a market reform and also advises on trading regulation for the government.
D
The head of a business unit of a bank petitions to the risk committee for a temporary risk limit increase for that unit.
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