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FRM Part II · FRM Exam Part II · Supervisory Guidance on Model Risk Management

A bank built a credit scoring model calibrated on prime auto loans. The business unit now applies it, unchanged, to approve subprime personal loans. The code is correct and has passed all its original validation tests. Which assessment is most consistent with SR 11-7?

The bank faces model risk from using the model outside its intended purpose. A technically correct, previously validated model can still mislead when applied to a different borrower population, so SR 11-7 expects revalidation or redevelopment for the new use rather than relying on earlier validation.

  1. ANo model risk exists because the model was validated and the code is free of errors
  2. BThe model risk stems from use outside its intended purpose, so the model needs revalidation for the new applicationCorrect
  3. CThe risk is purely implementation risk and is resolved by a code review
  4. DThe risk is a data-vendor issue and should be handled solely by procurement

Explanation

SR 11-7 states that models used beyond their intended purpose or for populations they were not designed for create model risk even if technically sound. Validation is specific to intended use, so the new use needs fresh validation. Passing earlier tests does not cover a different borrower population.

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