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FRM Part II · FRM Exam Part II · Case Study: Model Risk and Model Validation

A bank's model inventory lists 120 models. Internal audit finds that 18 models are used in production but absent from the inventory, and 12 listed models have not been validated within the policy cycle. Which governance conclusion is most appropriate under SR 11-7?

The inventory is incomplete and validations are overdue, so the bank cannot properly assess aggregate model risk. SR 11-7 expects a comprehensive inventory and periodic risk-based validation, with findings escalated to senior management and the board. Good past performance does not replace these governance controls.

  1. AThe inventory is incomplete and validation is overdue, so the firm cannot reliably aggregate model risk; remediation and escalation to senior management and the board are neededCorrect
  2. BOnly the 12 overdue models matter because unlisted models are low risk
  3. CThe findings are acceptable if model performance has been good
  4. DUnlisted models should be validated only after they cause a loss

Explanation

SR 11-7 expects a comprehensive inventory covering all models in use, and validation on a risk-based periodic schedule. Missing models (18 of 138 in use, about 13%) mean aggregate model risk cannot be assessed, and overdue validations add to this. Good past performance does not substitute for controls, and issues should be escalated.

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