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

A bank's board is reviewing model risk governance. Management proposes: (1) the board approves the model risk policy and receives periodic reports on aggregate model risk; (2) senior management allocates validation resources and ensures policy execution; (3) the model development team head, who also owns the largest trading model, sets validation priorities and signs off on its own model's validation. Which assessment is most consistent with SR 11-7?

Items one and two match SR 11-7: the board approves policy and oversees aggregate model risk, while senior management executes the policy and resources validation. Item three conflicts with the guidance because the model owner would control validation of its own model, removing the independence needed for effective challenge.

  1. AAll three are consistent, as ownership of validation priorities should rest with model owners
  2. BOnly (1) is consistent; senior management has no role in resourcing
  3. COnly (3) is consistent, as developers best understand model weaknesses
  4. D(1) and (2) are consistent, but (3) conflicts with the need for independence and effective challengeCorrect

Explanation

SR 11-7 assigns the board responsibility for approving policy and overseeing aggregate model risk, and senior management for implementing the policy and resourcing. Validation must be independent of development and use, with appropriate stature and incentives. Having the owner set priorities and sign off on its own model undermines independence.

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