Model risk management

Article

Model risk management

Building supervisory confidence

Models serve many important strategic purposes for financial services firms, and in many jurisdictions are relied upon in the regulatory framework. However, they can pose a number of risks for both financial services firms and the regulators monitoring them. In a policy environment that is broadly supportive of model use, how can firms build supervisory confidence in their models amid increasing regulatory scrutiny?

In this report, we discuss the current trends in the supervision of model risk management in financial services firms, drawing on our views and experiences to outline how financial services firms can apply practical model risk management to build supervisory confidence in models and modelling.

We specifically draw on the experience and expertise of Deloitte model risk management teams worldwide, working in those areas that are of greatest current concern to supervisors across financial services.

Firms that implement model risk management frameworks that satisfy both regulatory requirements and supervisors’ practical concerns, and operate at a commercially-viable cost, are, in our view, well-positioned to find a supportive policy environment for the use of models.

Firms need to demonstrate to supervisors that model risk is being managed across all stages of the model lifecycle. Overall, we expect supervisors to attach most importance to the board’s oversight and challenge of the model, to effectiveindependent model validation, and to the organisational status of model risk management which enables these. 

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Core to supervisors’ concerns are:

lu-effective-governance-1x1.jpg (133×133) Effective governance of models by the board, senior management and the risk management function, including board understanding of models and their limitations, individual accountability for models and modelling, model validation, and challenge to model builders.
Internal organisation that provides a model risk management function with sufficient formal influence, for example through direct reporting lines to the board, and appropriate allocation of responsibilities.
Model change and model development incentives, in particular whether there are inappropriate commercial pressures on the model builders and how these might translate into erosion of real capital cover. 
Unidentified use of material models, or use of models in ways for which they were not intended. 
Systemic risks, including systematised approaches or errors (including through “herding” around common approaches) that may lead to destabilising effects in a crisis. 

How Deloitte can help

With a team of more than 700 professionals covering all aspects of model risk, Deloitte has implemented leading practices at organisations across financial services and developed and implemented technological solutions to help clients achieve scale and sustainability across all components of their model risk management frameworks, while complying with the strictest regulatory rules.

About the EMEA Centre for Regulatory Strategy

The Deloitte Centre for Regulatory Strategy is a powerful resource of information and insight, designed to assist financial institutions manage the complexity and convergence of rapidly increasing new regulation.

With regional hubs in the AmericasAsia Pacific and EMEA, the Centre combines the strength of Deloitte’s regional and international network of experienced risk, regulatory, and industry professionals – including a deep roster of former regulators, industry specialists, and business advisers – with a rich understanding of the impact of regulations on business models and strategy.

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