Model risk management

As the financial crisis so amply demonstrated, the risks posed by models that are inaccurate, misused or misunderstood can be close to catastrophic. Little wonder that since then, financial regulators including The Federal Reserve, The Bank of England and the European Central Bank have all focused on model risk management (MRM) as a core capability that financial institutions must get right.

In response, financial institutions have been maturing their approach to MRM. But as models become more complex and pervasive, and regulatory expectations continue to increase, leading financial institutions are seeking to move faster and further. By re-examining their approach to model risk management they’re aiming to create flexible, adaptable and efficient MRM functions that are fit for the future and will deliver real business value.

What do we think these will look like? By 2020, we believe that leading future MRM functions will reflect three main characteristics as high performing, enterprise-wide business enablers:

  • they will have a holistic mandate and encompass diverse skills embracing technology, regulation and analytics;
  • they will be seamlessly joined up between modelling, reporting and monitoring; and
  • they will be agile, integrated and responsive to organisational and regulatory change.

Achieving that transformation requires development across a number of areas. Processes and policies need to change to reflect models’ complexity and materiality that will determine the degree of oversight and governance required. More automation will be introduced to standardise and industrialise model validation procedures and libraries to drive rapid assessment and deployment. In addition, approaches such as robotic process automation (RPA) can execute routine and repetitive tasks far more efficiently.

New technology approaches will be necessary to support and enterprise-level centralised data platform that can serve as a single source of the truth for model risk activities such as validation, monitoring and reporting. In addition, workflow tools can connect together MRM components to enhance the effectiveness and transparency of governance and oversight. And finally, changes to the MRM operating model should secure cost effectiveness and efficiency by moving from a solely in-house function to a hybrid model that leverages strategic outsourcing partnerships.

We believe that financial institutions will gain significant value from accelerating their journey to a next-generation more simplified and automated MRM function. And there are a number of key opportunities to take action and start making progress. These embrace policies, processes, technology and people. Clarity of roles and responsibilities and the alignment of key model management activities is as important as the appropriate use of digital technologies such as RPA, machine learning and advanced analytics. Cultivation of the right talent mix and culture is vital, as is the development of a common data platform. Developing the right mix of centralised centres of excellence and outsourced lower-risk activities is important, along with the development of risk-based process and controls optimisation. 

The goal is a model risk management function that is fully embedded in business decision-making and enables proactive risk management. Each financial institution will take a different path according to their strategic vision, current capabilities and regulatory context. But it’s a destination to which all need to set their sights.

Ashutosh Nawani | Director
Profile | Email | +44 (0)7703 563615

Read more articles on