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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 developed by the retail risk team. The same team lead also performs the annual validation to save cost. Which SR 11-7 principle is most clearly violated?

The principle of effective challenge is violated. SR 11-7 expects validation to be done by competent staff independent of model development and use, with sufficient authority and incentives to challenge. A developer's team lead validating their own model removes that independence and objectivity.

  1. AEffective challenge requires validation by staff independent of model development, with appropriate incentives and influenceCorrect
  2. BThe board must personally approve each model parameter
  3. CModels must be validated only by external vendors
  4. DValidation is required only when a model fails back-testing

Explanation

SR 11-7 requires effective challenge: objective, informed critical review by people independent of development and use, with competence and authority. Having the developer's lead validate the model undermines independence. External vendors are not mandated, and the board sets policy rather than approving parameters.

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