The joint responsibility for front- and back-office functions makes the bank more vulnerable to trading frauds. This is because the front office is typically responsible for generating business (i.e., making trades), while the back office is responsible for the administration and support functions, such as trade confirmation and settlement. When these two functions are combined, it can create a conflict of interest and increase the risk of fraudulent activities. This is because the same person who is making the trades is also responsible for confirming and settling those trades. This lack of segregation of duties can allow fraudulent activities to go undetected, as the person could potentially manipulate the records to hide trading losses. This was the case with Barings Bank, where Nick Leeson was given joint responsibility for front- and back-office functions, which allowed him to hide trading losses in a special 'error' account.

Choice A is incorrect. While having an advanced credit risk management system is a positive aspect, it does not necessarily mean that the bank's risk management practices are satisfactory. The effectiveness of the system depends on how well it is implemented and used in practice. It also depends on other factors such as the quality of data input into the system, the skills and knowledge of those using it, and whether there are adequate checks and balances in place.

Choice B is incorrect. The ability to generate VaR reports alone does not guarantee satisfactory risk management practices. VaR reports provide a measure of potential losses under normal market conditions but they do not capture tail risks or extreme events which can lead to significant losses for a bank. Furthermore, these reports need to be interpreted correctly by skilled personnel for effective risk management.

Choice C is incorrect. The frequency of reporting to RMC should be determined based on various factors such as complexity of operations, volatility in markets etc., rather than being increased arbitrarily without considering these factors.

Things to Remember

• VaR (Value at Risk) is a widely used risk management measure that quantifies the potential loss in value of a risky asset or portfolio over a specified time period under normal market conditions.
• Segregation of duties is a key internal control principle that aims to prevent fraud and errors by dividing responsibilities among different individuals or departments.
• Operational risk is the risk of loss resulting from inadequate or failed internal processes, people, and systems, or from external events.
• Market risk is the risk of losses in on and off-balance sheet positions arising from adverse movements in market prices.
• Credit risk is the risk of loss due to a borrower's failure to make payments on any type of debt.