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FRM Part II · FRM Exam Part II · Capital Planning at Large Bank Holding Companies: Supervisory Expectations and Range of Current Practice

A BHC uses a vendor loss model for its auto loan portfolio and cannot access the model's internal logic. According to supervisory expectations for capital planning, what is the most appropriate handling?

The BHC should validate the vendor model as far as possible through benchmarking and outcomes analysis, understand its limitations, and apply compensating overlays where gaps remain. Reliance on reputation, excluding the portfolio, or picking the lowest loss output does not meet supervisory expectations.

  1. ATreat the output as reliable because the vendor is reputable and skip validation
  2. BValidate the model to the extent possible, including benchmarking and outcomes analysis, understand its limitations, and use compensating adjustments or overlays where gaps remainCorrect
  3. CRemove the portfolio from stress testing
  4. DUse the vendor model only if it produces lower losses than internal estimates

Explanation

Vendor or third-party models remain subject to the BHC's model risk governance. The firm should perform what validation it can (benchmarking, backtesting, sensitivity) and compensate for opacity with adjustments. Excluding the portfolio or selecting the lower loss output is not acceptable.

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