FRM Part II · FRM Exam Part II · Supervisory Guidance on Model Risk Management
A business unit wants to use a model built for pricing retail loans to set capital for small-business loans, with no changes. Under supervisory guidance, what is the most appropriate response?
Using a model beyond its original purpose is a new use, so the bank must assess its suitability, perform further validation as needed, and apply limits or compensating controls. A prior validation for a different product does not automatically carry over.
- AApprove, since both are lending products and the model is already validated
- BApprove if the model's R-squared exceeds a set threshold
- CTreat it as a new use requiring assessment of suitability, possibly further validation, and limits or compensating controlsCorrect
- DApprove, with validation deferred until the first annual review
Explanation
Guidance states that using a model outside its original intended purpose requires a fresh look at whether it is appropriate, and validation must reflect the new use. A prior validation does not cover a different portfolio, and R-squared alone is not adequate.
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