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

A bank's VaR model shows 9 exceptions in 250 days at 99% confidence, while a validator notes the model passed an annual back-test last year. Its inputs have since shifted markedly, and the validator proposes relying on last year's result until the next scheduled validation in 12 months. Which action is most consistent with supervisory guidance?

The bank should perform an interim review or revalidation. Supervisory guidance requires periodic validation plus additional validation when market conditions or model performance change materially. Nine exceptions against about 2.5 expected is a warning sign, so waiting a year or tweaking the confidence level would be inappropriate.

  1. AAccept, since a passed validation remains valid until the next scheduled review
  2. BReplace the model immediately without any analysis, since exceptions exceed the expected 2.5
  3. CConduct an interim review or revalidation, because material changes in market conditions and weak performance warrant earlier validation than the periodic scheduleCorrect
  4. DIncrease the confidence level to 99.9% to reduce exceptions

Explanation

Guidance calls for validation at regular intervals and also when material changes in products, exposures, activities or market conditions occur, supported by ongoing monitoring. Nine exceptions versus an expected 2.5 is a clear performance signal. Automatically replacing the model skips analysis, and changing the confidence level does not address model deficiencies.

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