Explanation:
B is correct. Implementing the Basel principles will help reduce the bank’s exposure to model risk by increasing the integrity of the data used as inputs into the models. Data acquisition plays an important role in model risk. Financial institutions rely on models to guide their day-to-day operations and to analyze their risk exposures. As a result, even the smallest of model errors can have dire consequences. Model risk can be decomposed into four components: input risk, estimation risk, valuation risk, and hedging risk. Note that data acquisition is especially pertinent when considering input risk. Models depend on the quality of data because it is used to create statistical estimators of their parameters. As the adage goes: "garbage-in, garbage-out".
A is incorrect. BCBS 239 was a major driver in the rise of the chief data officer (CDO) function. The CDO is typically responsible for standardizing a firm's approach to data management. Note that data standardization efforts have grown well beyond reference data to include financial products data and accounting data. If independent departmental applications and methodologies are based on consistent standards, the data that flows up through an organization's structure will provide a reliable, accurate, and manageable view of the institution's total risk profile. If this is not the case, however, important connections among different dimensions of an organization's business will not be transparent.
C is incorrect. The Basel principles become more difficult to implement as more AI techniques are introduced, as AI techniques are highly complex. The exponential increase in the application of AI techniques will impose additional challenges to the compliance with Basel principles.
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Q-30. The board of directors of a mid-size bank has recommended that the bank adopt the Basel principles for data aggregation and risk reporting. The bank currently has three different business units for its retail banking, commercial banking, and credit card operations. It also maintains some internally developed models and is introducing artificial intelligence (AI) techniques in data management. In assessing the impact and best practice of complying with the Basel principles for data aggregation and risk reporting, which of the following statements is most appropriate?
A
Business units of the bank should adopt departmental applications and methodologies for data management that are customized for each business unit.
B
Complying with the Basel principles should reduce the bank’s exposure to model risk as the quality of data input in a model will likely improve.
C
An exponential increase in the application of AI techniques in data management is not likely to impose additional challenges to the compliance with Basel principles.
D
The Basel principles recommend that the bank outsource its model validation function to an external third party in order to provide an independent review.