medium · FRM Part 2 Operational Risk
A bank's Internal Rating Based (IRB) model for a loan portfolio produces a Probability of Default (PD) of 2%. The bank's validation team notes that the 'Accuracy Ratio' (AR) of the model has dropped from 0.75 to 0.45.
What is the primary concern for the bank?
- The model's Type 1 error rate in backtesting has become far too high, leading to excessive capital charges
- The model's discriminatory power is failing; it can no longer effectively distinguish between 'good' and 'bad' borrowers.
- The model's calibration is failing outright, since the predicted 2% PD diverges sharply from realized historical defaults
- The model's LGD estimate is likely overstated now, since LGD and the Accuracy Ratio move together across credit cycles historically
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