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

A bank uses a model built for retail mortgage loss forecasting to estimate losses on a newly acquired commercial real estate book, reasoning that both are secured by property. Which statement best reflects supervisory guidance on model use?

Applying the mortgage model to commercial real estate is a new use, so suitability must be assessed and the model likely revalidated. Model risk arises when a model is used beyond its design, and the two portfolios have different drivers. Informal approval or conservative rounding does not substitute for this.

  1. AReuse is acceptable because the collateral type is the same
  2. BReuse is acceptable if the developer verbally approves it
  3. CReuse is acceptable provided results are rounded conservatively
  4. DUsing the model for a new purpose or population requires assessing its suitability, and likely revalidation, because model risk arises from use beyond the original designCorrect

Explanation

Guidance stresses that models be used consistent with their intended purpose and that new applications, products or populations trigger reassessment and validation. Differences in borrower behavior, cash flows and drivers between retail mortgages and commercial real estate make reuse unsafe without review. Verbal approval or rounding is not a control.

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