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

A risk manager is asked what a bank's model risk policy should say when a model with known limitations must be used before validation is complete. Which provision best fits supervisory guidance?

The policy should allow use only as a documented, approved exception with compensating controls, such as conservative adjustments or limits, and a set deadline for completing validation. Developer sign-off or a lack of losses is not sufficient, and an absolute ban is not what guidance requires.

  1. AUse should be permitted only as an approved exception, with documented rationale, compensating controls such as conservative overlays and limits, and a deadline for completing validationCorrect
  2. BUse should be permitted freely provided the developer signs off on accuracy
  3. CUse should be prohibited in all circumstances, with no exceptions
  4. DUse should be allowed indefinitely if no losses have occurred

Explanation

Guidance recognizes that exceptions may be needed but requires them to be controlled: documented, approved, accompanied by compensating controls and time-bound. Developer sign-off is not independent, a blanket ban ignores practical needs, and absence of losses does not demonstrate model soundness.

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