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FRM Part I · FRM Exam Part I · Enterprise Risk Management and Future Trends

A bank's risk committee is reviewing the use of a machine-learning model to approve small-business loans. Which concern is most directly an emerging model risk raised by this practice, as opposed to a traditional credit risk concern?

The key emerging concern is lack of interpretability. Complex machine-learning models can be hard to explain and validate, so decisions may be opaque and biased. Default, prepayment and collateral shortfall are traditional credit risks that arise with any approval method, not new model risks.

  1. AThe borrower may default if sales decline
  2. BThe model may be difficult to interpret, making its decisions hard to explain and validateCorrect
  3. CThe loan may be repaid early, reducing interest income
  4. DThe collateral value may fall below the loan balance

Explanation

Machine-learning models are often opaque, which creates explainability and validation challenges, a model risk concern. The other options describe borrower default, prepayment and collateral risk, which are traditional credit-related risks that exist regardless of the modeling technique.

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