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FRM Part II · FRM Exam Part II · Governance

A bank's internal probability of default model is used for loan pricing and capital allocation. Which arrangement best supports sound governance of this model?

Best practice is independent, ongoing validation by staff separate from model development and use, with findings escalated to senior management and the board and with formal approval of model changes. Developer self-validation or one-time validation lacks effective challenge and ignores model performance deterioration over time.

  1. AThe model developers also perform the annual validation to ensure deep familiarity with the model
  2. BIndependent validation by staff separate from development and use, with findings reported to senior management and the board, and model changes subject to approvalCorrect
  3. CValidation performed only at initial implementation, since the model is statistically calibrated
  4. DBusiness-line users own the model assumptions and approve overrides without documentation

Explanation

Sound model governance requires effective challenge: validation independent of developers and users, ongoing rather than one-off, with escalation of findings and controlled change approval. Developer self-validation lacks independence, and one-time validation ignores model drift.

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