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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

During a review of a BHC's capital planning, supervisors find that stress test results for the loan book rely on a loss model calibrated only to a benign period with no recessions. What is the most appropriate supervisory criticism?

A model calibrated only to benign data likely understates stressed losses. The firm should extend data, apply adjustments or management overlays, and document model limitations. Good documentation or using average historical losses does not make results reflect stress conditions.

  1. AThe model is acceptable if it is simple and well documented
  2. BEstimates may understate losses under stress, so the firm should use longer data, adjustments or overlays and document the limitationsCorrect
  3. CLoss models should be replaced with the supervisor's models entirely
  4. DStress losses should be set equal to average historical losses

Explanation

Models calibrated to benign data may not capture stressed relationships, so losses are likely understated. Firms should use broader data, expert adjustments or overlays and clearly disclose limitations. Documentation alone does not fix bias, and average losses are not stressed losses.

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