FRM Part II · FRM Exam Part II · Supervisory Guidance on Model Risk Management
A bank's market risk team uses a vendor-supplied option pricing model. The vendor refuses to share source code, citing proprietary rights. A model validator proposes to skip validation because internal review is impossible. Which response is most consistent with SR 11-7?
The bank should still validate the vendor model using available methods such as benchmarking, sensitivity testing, outcomes analysis, and vendor documentation, plus compensating controls like conservative overlays. SR 11-7 does not allow proprietary restrictions to excuse the bank from managing the model risk.
- AAccept the proposal, since vendor models are the vendor's responsibility
- BValidate through available means such as benchmarking, sensitivity and outcomes analysis, and testing with the vendor's documentation, and use compensating controls such as conservative adjustments or overlaysCorrect
- CProhibit any use of the model permanently
- DRely solely on the vendor's own validation report
Explanation
SR 11-7 expects vendor models to be validated even when code is proprietary. Banks should obtain developmental evidence, perform ongoing monitoring and outcomes analysis, benchmark, and use compensating controls where transparency is limited. Skipping validation or relying only on the vendor leaves model risk unmanaged, and an automatic ban is not required.
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