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

A bank's credit team is building a new loan-pricing model under supervisory guidance on model risk management (SR 11-7 style). Which activity is a core expectation of the development stage, before the model is put into use?

Development should include documenting the model's theory, assumptions, data and limitations, and testing it to show it performs as intended before use. Deferring assessment, hiding overrides, or relying only on vendor assurance fails the guidance's expectation of sound, evidenced development.

  1. ADocumenting the model's theory, assumptions, data and limitations, and testing it to show it performs as intendedCorrect
  2. BWaiting for the first annual review to confirm that the model's assumptions are reasonable
  3. CAllowing business users to adjust model outputs without recording the overrides
  4. DRelying on the vendor's assurance in place of any internal testing of the model

Explanation

Guidance expects development to rest on a clear purpose, sound theory, documented assumptions and data, and testing that shows the model works as intended. Postponing assessment to an annual review leaves the model untested at launch. Undocumented overrides and blind reliance on vendors contradict the guidance.

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