Complying with the new supervisory guidance on Model Risk

Original by RMA journal, Shaheen Dil, 2012, 5 pages 

This summary note was Posted on

The new framework is more comprehensive. Banks are now required to identify sources of model risk, asses the magnitude and establish a framework to manage it.

Three processes

1 – Robust model development, implementation and use

  • Emphasis on the early stage of model development
  • Technical expert should work with the business
  • Rigourous assessment of data quality and relevance
  • Comprehensive model testing (potential limitations, sensitivity analysis)
  • Sound model-validation practices
  • A global governance framework

2 – Sound Model validation pratices

  • External models should be subject tonthe same intenal models governance
  • Validation must be conducted with a certain degree of independence
  • Models should be reviewed at least annually or whenever major changes are made or economic situation changes
  • Validation framework elements
    • Conceptual soundness
    • Ongoing monitoring and process verification
    • Outome analysis and backtesting

3 – Solid governance framework

  • A bank wide approach to managing model risk
  • Internal Audit should safegard the right application of the model risk management processes

Key elements

First line of defense (developpers)

  • robust change control tracking and process
  • usual  basel standards on data and model development
  • procedure checklist followed by modellers
  • documentation

Second line of defence (validator)

  • Strengthen existing model validation group
  • compile a comprehensive model inventory 
  • (not mandatory) designate a full-time model risk officer for medium sized and larger banks

Getting started

Key suggestions

  • Conduct internal gap analysis
  • Develop a training module on model risk management