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

A bank's credit-scoring model was built by a quantitative team and then put into production. The head of model risk wants an independent check that the model's conceptual design, assumptions and data are sound before it is used for lending decisions. Which action best delivers this objective?

An independent validation team performing effective challenge before approval best meets the objective. Independence from the developers ensures objective review of design, assumptions and data, whereas self-review, vendor assurances or generic capital buffers do not test whether the model suits the bank's own use.

  1. AHaving the model's developers re-run their own back-tests and sign off the results
  2. BHaving a validation team that is independent of the developers perform effective challenge of the model before approvalCorrect
  3. CRelying on the vendor's documentation that the model has been used by other banks
  4. DIncreasing the capital buffer held against all lending exposures

Explanation

Supervisory model risk guidance calls for effective challenge by objective, competent people independent of model development. Developer self-review lacks independence, vendor use elsewhere does not validate fit for this bank's portfolio, and a general buffer does not test the model itself.

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