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 is 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; the predicted 2% PD is significantly different from realized default rates.
- The model's LGD estimate is likely overstated, as LGD and AR are positively correlated.
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