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

A bank's risk committee debates how to manage model risk. Which view is most consistent with SR 11-7?

Model risk cannot be eliminated and must be actively managed. SR 11-7 expects effective challenge, independent validation, ongoing monitoring, and limits on model use, with the rigor proportionate to the bank's exposure. Reliance on developers alone or on vendors does not remove the bank's responsibility.

  1. AModel risk cannot be eliminated, so it should be managed by limiting use, challenging models, and controlling it like other risks, with rigor commensurate with exposureCorrect
  2. BModel risk is eliminated once a model passes initial validation, so ongoing monitoring is optional
  3. CModel risk should be managed only by the model developers, who understand the model best
  4. DModel risk is avoided by using only vendor models, since vendors carry the risk

Explanation

SR 11-7 states that model risk cannot be eliminated but can be managed through effective challenge, validation, limits on use, and governance with rigor suited to the bank's risk exposure. Ongoing monitoring is required, independence from developers is expected, and vendor models still require validation by the bank.

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