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Answer: Establish a continuous process of model risk management and validation rather than a process that conducts reviews at specific points in time.
**Correct Answer: D** **Explanation:** D is correct. Model risk management should be seen as a continuous effort rather than a point in time process that emphasizes periodic validation and review. While this makes the process more resource intensive, it helps the bank respond more quickly to increasingly dynamic market conditions with more frequent recalibrations of the models. **Why other options are incorrect:** - **A is incorrect:** If some internal audit staff perform certain validation activities, they should not be involved in the assessment of the firm's overall model risk management framework. This creates a conflict of interest and compromises the independence of the validation process. - **B is incorrect:** Ongoing monitoring is a core element of the validation process and should begin when the model is first implemented in production systems for actual business use. Backtesting results are typically not available for a significant period of time after the model is put into production so beginning the monitoring process after the backtest would be too late. - **C is incorrect:** Vendor models are often designed to provide a range of capabilities and therefore might need to be customized by a bank to meet its specific operating circumstances. Banks should always verify whether any inputs or assumptions provided by the vendor remain relevant for the bank and the current operating conditions, and should document any customization to these models that is made. **Key Learning Points:** - Model validation should be a continuous process, not just periodic reviews - Independence between validation and audit functions is crucial - Ongoing monitoring should start immediately upon model implementation - Vendor models require customization and validation for specific bank circumstances
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The board of directors of a fast-growing US-based bank is discussing a report of findings and recommendations issued after a recent regulatory review of the bank's risk management framework. A board member notes that the regulators have identified deficiencies in the bank's model validation process, and recommends that the CRO develop a plan for improvement in this area. The CRO consults the Federal Reserve guidelines for examples of best practices, and identifies ways that the bank can improve its validation approaches to conform with the guidelines. Which of the following recommendations is appropriate for the CRO to make?
A
Require internal auditors that are responsible for assessing the bank's model risk management framework to also validate and backtest the models.
B
Begin monitoring the performance of each model only after the backtest of the model has been successfully completed.
C
Ensure that any third-party vendor models used by the bank are implemented under the assumptions that were initially provided by the vendor.
D
Establish a continuous process of model risk management and validation rather than a process that conducts reviews at specific points in time.