hard · FRM Part 2 Operational Risk
A Chief Risk Officer (CRO) is reviewing the bank's model risk tiering system. The current inventory has 50 Tier-1 models (e.g., pricing engines for exotics), 150 Tier-2 models, and 300 Tier-3 models.
If the validation team has a capacity of 800 reviewer-weeks per year and Tier-1 models require 10 weeks each for a full annual validation, what is the most significant structural risk if Tier-2 models are scheduled for 4 weeks of review every two years?
- Tier-3 models are structurally over-weighted in the annual resource allocation schedule, leading to superficial, rushed reviews in Tier-1.
- The mandatory 10-week annual validation period assigned to each Tier-1 model is excessive compared to the Basel benchmark cycle of only 4 weeks.
- The newly adopted biennial review cycle for Tier-2 models mechanically creates a Type I error risk within the VaR-based backtesting framework used firm-wide.
- The validation backlog will leave Tier-1 models stale as capacity is exceeded (500 Tier-1 + 300 annualized Tier-2 = 800 weeks, leaving zero for Tier-3).
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