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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.
## Explanation According to Federal Reserve SR 11-7 guidelines on model risk management, model validation should be a **continuous process** rather than a one-time or periodic activity. The key principles include: - **Option D is correct**: Establishing a continuous process of model risk management and validation aligns with regulatory expectations that model validation should be ongoing throughout the model's lifecycle, not just at specific points in time. **Why other options are incorrect:** - **Option A**: Internal auditors should maintain independence and objectivity by not performing both assessment and validation functions. Segregation of duties is crucial. - **Option B**: Model monitoring should begin immediately upon implementation, not wait for backtesting completion. Backtesting is part of ongoing validation. - **Option C**: Third-party models require the same rigorous validation as internally developed models, not just implementation under initial vendor assumptions. The Federal Reserve emphasizes that effective model risk management requires ongoing validation processes that adapt to changing conditions, new data, and model performance over time.
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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 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.
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