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FRM Part II · FRM Exam Part II · Case Study: Model Risk and Model Validation

Under SR 11-7, how should a bank treat a model whose validation found significant limitations that cannot be fixed immediately but that the business wishes to keep using?

The bank may keep using the model only with documented compensating controls, such as conservative adjustments, usage limits and enhanced monitoring, and with the limitations reported to senior management. Ignoring findings or hiding the model from the inventory violates the guidance.

  1. AContinue use without restriction since the model is already approved
  2. BPermit use with documented compensating controls such as conservative adjustments, tighter monitoring, and limits, and report it to senior managementCorrect
  3. CRemove it from the model inventory to avoid scrutiny
  4. DAllow use provided the developers sign off on the findings

Explanation

SR 11-7 allows use of models with known limitations if the limitations are understood and managed, for example by overlays, conservative inputs, use limits and enhanced monitoring, with findings escalated. Removing it from the inventory hides risk, and developer sign-off does not replace independent oversight.

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