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FRM Part II · FRM Exam Part II · Capital Planning at Large Bank Holding Companies: Supervisory Expectations and Range of Current Practice

A bank estimates losses on a mortgage portfolio using a roll-rate model and separately benchmarks results using a regression model of loss rates on unemployment and house prices. The two methods give materially different stressed losses. According to supervisory expectations, what is the most appropriate response?

The bank should investigate why the two methods diverge, judge which better captures the scenario, and document any adjustment or conservative selection with its rationale. Picking the lower estimate, averaging without analysis, or abandoning models for judgment does not meet supervisory expectations for rigor.

  1. AAlways adopt the lower estimate to preserve capital ratios
  2. BDiscard both models and use management judgment
  3. CAverage the two outputs without analysis and avoid documenting the difference
  4. DInvestigate the reasons for the divergence, assess which better reflects the scenario, and document any adjustment or conservative choice along with the rationaleCorrect

Explanation

Benchmarking and challenger models are meant to expose weaknesses. Supervisors expect the bank to understand why results diverge, then justify the selected estimate or overlay. Choosing the lower figure is non-conservative, and undocumented averaging or pure judgment lacks rigor.

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