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FRM Part II · FRM Exam Part II · Case Study: Model Risk and Model Validation

A bank purchases a vendor-built market risk model whose code and methodology details are proprietary. Which expectation under SR 11-7 applies to the bank?

The bank remains responsible for validating the vendor model. When proprietary details are withheld, it should lean on sensitivity analysis, benchmarking, ongoing monitoring and outcomes analysis and document the limitations. A vendor certificate or the vendor's regulated status does not replace the bank's own validation.

  1. AValidation is the vendor's responsibility, so the bank only needs the vendor's certificate
  2. BThe bank must still validate the model and use sensitivity analysis, benchmarking and outcome analysis where full detail is unavailableCorrect
  3. CThe model may be used without validation if the vendor is a regulated firm
  4. DThe bank must obtain the source code or stop using the model

Explanation

SR 11-7 states that vendor models need validation like internal ones; where proprietary details are withheld, banks should rely more on ongoing monitoring, benchmarking, sensitivity analysis and outcomes analysis, and should document the limitation. Reliance on the vendor's certificate alone is inadequate.

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