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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's loss model for credit card balances was developed using data from a benign period only. During stress testing review, which concern is most important?

The key concern is that a model built only on benign-period data may understate losses in a severe downturn. The BHC should recognize the limitation, supplement with external data or judgment, and apply documented conservative adjustments rather than relying on benign-period results.

  1. AThe model may not capture loss behavior in severe downturns, so the BHC should assess data limitations, supplement with external data or judgment, and apply conservative adjustmentsCorrect
  2. BThe model is invalid only if it uses more than one risk driver
  3. CBenign-period data always overstate losses, so no adjustment is needed
  4. DThe model should be replaced by the prior year's actual losses

Explanation

Data lacking stress observations leads to underestimating tail losses. Practice is to recognize the limitation, bring in external or longer data, use judgment overlays, and be conservative, with the uncertainty documented. Benign data understate rather than overstate stress losses.

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