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P2.T7.20.3. Model risk management (according to FDIC)

Nicole Seaman

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Learning objectives: Describe model risk and explain how model risk can arise in the implementation of a model. Describe elements of an effective process to manage model risk. Explain best practices for the development and implementation of a model. Describe elements of a strong model validation process and challenges to an effective validation process.

(reference is “Supervisory Guidance on Model Risk Management,” Federal Deposit Insurance Corporation, June 7, 2017)

20.3.1. Which of the following is the BEST guiding principle for managing model risk?

a. Effective challenge
b. Model development
c. Regulatory compliance
d. Latest and best technology

20.3.2. According to the FDIC, model risk management starts with robust model development, implementation, and use (aka, the first element. The second element is a sound validation process. The third element is governance). Which of the following is a TRUE statement about this first element (development, implementation and use) of model risk management?

a. Model development should be a straightforward and routine technical process
b. To exercise conservatism, pick an extreme point on a given modeled distribution
c. Banks should never model output with judgmental or qualitative adjustments
d. Although the nature of testing varies by the context and type of model, testing is an integral part of model development

20.3.3. According to the FDIC, an effective model (risk) validation framework should include three core elements. What are the three core elements?

a. Implementation; ongoing error correction; and reporting
b. Evaluation of sound governance; back-testing; and vendor validation
c. Evaluation of conceptual soundness; ongoing monitoring; and outcomes analysis
d. Evaluation of simulated errors; expert screening; and policy/procedure validation

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