Module: | MODULE B: RISK MANAGEMENT
Q272: Scenario: XYZ Bank experiences a sudden, extreme drop in the market value of its sovereign bond portfolio, due to an unexpected RBI rate hike. The treasury dealers wish to hold the losing positions, hoping the market will eventually recover. Based on the guidelines for Risk Control, consider the following statements regarding the correct regulatory actions:
1. The Risk Management Department must enforce strict stop-loss limits, instantly mandating the liquidation of the losing positions to prevent further capital erosion.
2. The bank must utilize exposure limits, strictly restricting the maximum amount of capital deployed in any single asset class or counterparty.
3. The treasury dealers should be granted overriding authority, allowing them to bypass risk control limits during periods of extreme market stress.
Which of the statements given above is/are correct?
2. The bank must utilize exposure limits, strictly restricting the maximum amount of capital deployed in any single asset class or counterparty.
3. The treasury dealers should be granted overriding authority, allowing them to bypass risk control limits during periods of extreme market stress.
Which of the statements given above is/are correct?
✅ Correct Answer: B
The correct answer is B. Statement 1 is correct: Stop-loss limits are a critical risk control mechanism.
They remove human emotion (like a dealer hoping the market will bounce back) from the trading floor.
Once a pre-defined threshold of loss is reached, the system mandates the immediate liquidation of the position to protect the bank's core capital from further erosion.
Statement 2 is correct: Exposure limits are pre-set boundaries that restrict how much credit or market risk a bank can take against a single counterparty, industry, or geographic region, thereby strictly preventing concentration risk.
Statement 3 is incorrect: Granting treasury dealers the authority to override or bypass risk limits, especially during market stress, defeats the entire purpose of a risk management framework.
Risk limits are non-negotiable hard boundaries enforced by the independent Risk Management Department (RMD) specifically to prevent catastrophic rogue trading losses.
They remove human emotion (like a dealer hoping the market will bounce back) from the trading floor.
Once a pre-defined threshold of loss is reached, the system mandates the immediate liquidation of the position to protect the bank's core capital from further erosion.
Statement 2 is correct: Exposure limits are pre-set boundaries that restrict how much credit or market risk a bank can take against a single counterparty, industry, or geographic region, thereby strictly preventing concentration risk.
Statement 3 is incorrect: Granting treasury dealers the authority to override or bypass risk limits, especially during market stress, defeats the entire purpose of a risk management framework.
Risk limits are non-negotiable hard boundaries enforced by the independent Risk Management Department (RMD) specifically to prevent catastrophic rogue trading losses.