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

A bank's risk committee reviews its approach to model risk. Which statement is most consistent with SR 11-7 on how model risk should be managed?

Model risk should be managed like any other risk, with rigor matched to the bank's exposure and effective challenge as a core principle. It cannot be eliminated, vendor models still need validation, and the guidance covers all models affecting decisions, not only regulatory capital models.

  1. AModel risk can be eliminated by purchasing models from reputable vendors
  2. BModel risk should be managed like other risks, with the level of rigor commensurate with the bank's exposure, and with effective challenge as a key principleCorrect
  3. COnly models used for regulatory capital need to be subject to validation
  4. DModel risk is limited to the quantitative accuracy of outputs and not the decisions made using them

Explanation

SR 11-7 states that model risk cannot be eliminated but should be managed like other risks, with rigor commensurate with the bank's exposures, and relies on effective challenge. Vendor models still require validation, the guidance applies to all models that materially affect decisions, and model risk concerns adverse consequences of decisions based on incorrect or misused outputs.

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