Explanation:
Risk management is about identifying, assessing, and mitigating risks to acceptable levels, not about perfectly eliminating all potential for loss. An event with a 1% probability is rare but will statistically occur. Simply experiencing a loss in the estimated tail end (such as the USD 650 million loss which is USD 500 million) does not inherently imply that the probability estimates were wrong or that risk management failed. Without further details on the risk management framework's specifics, we cannot conclusively label this event as a risk management failure.
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Q.65 Peter Drury, FRM, serves as the chief risk officer at Capital bank. He recently finalized a comprehensive risk assessment on a series of investments in credit default swaps. According to his estimates, the portfolio had a 1% chance of losing USD 500 million or more over one year, a big enough loss to trigger insolvency or attract takeover bids. Based on Drury’s assessment, Capital Bank’s CEO authorized a large investment in additional swaps. At the end of the first year, the portfolio had lost USD 650 million. The bank was immediately closed down by the regulator, pending a comprehensive audit and review of the bank’s investment policies. Which of the following statements is correct?
A
The outcome demonstrates risk management failure because the CRO failed to foresee a move by the regulator, neither did he attempt to stop the shutdown
B
The outcome demonstrates an outright risk management failure because the occurrence of a supposedly extreme event means the probability of such an outcome was poorly estimated
C
The outcome demonstrates risk management failure because the CRO did not eliminate the chance of a financial loss
D
On the basis if the information provided, one cannot conclusively determine whether this was a risk management failure
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