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FRM Part II · FRM Exam Part II · Governance

A bank's internal credit rating model was developed by the retail credit team, which also performs the annual validation and reports results directly to the head of retail lending. Which governance weakness is most evident?

The main weakness is the lack of independence between model development and validation. The team that built the model also validates it and reports to the business head, creating a conflict of interest. Effective governance needs validation performed independently of developers and of the lending business using the model.

  1. ALack of independence between model development and validationCorrect
  2. BExcessive use of quantitative methods in the model
  3. COverly frequent validation of the model
  4. DToo much board involvement in model approval

Explanation

Sound model governance requires validation to be independent of development and of the business line that uses the model, with reporting lines that avoid conflicts of interest. Here the developer validates its own model and reports to the business head, compromising objectivity. Frequency of validation and quantitative methods are not the issue.

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