FRM Part II · FRM Exam Part II · Supervisory Guidance on Model Risk Management
A bank licenses a pricing model from an external vendor that treats its code as proprietary and refuses to share it. Under supervisory guidance on model risk management (SR 11-7), which approach is most appropriate for the bank's validation of this model?
The bank should validate the vendor model as far as it can using documentation, benchmarking, outcomes analysis and sensitivity tests, and apply compensating controls such as use limits. Supervisory guidance does not allow reliance solely on vendor assurances or an exemption because the code is proprietary.
- ARely on the vendor's own validation report, since the bank cannot see the code
- BExempt the model from validation and apply a conservative capital add-on instead
- CValidate the model using available vendor documentation, benchmarking, outcomes analysis and sensitivity testing, and set limits on use where full validation is not possibleCorrect
- DReplace the model with an internally built one before any use is allowed
Explanation
Guidance expects banks to validate vendor models as far as possible even without access to code. Tools include reviewing developmental evidence, benchmarking against alternative models, outcomes analysis and sensitivity tests, with compensating controls such as conservative limits. Relying only on the vendor's report or exempting the model is not acceptable.
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