Model Risk Management in Financial Services
Building supervisory confidence amid regulatory scrutiny
While models serve important strategic purposes and are widely used in the regulatory framework, they can also be a source of risk for both financial services firms and the regulators monitoring them. In an environment supportive of model use, what can firms do to build supervisory confidence in their models?
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 effective, independent model validation, and to the organisational status of model risk management which enables these. In line with this expectation, the European Central Bank provides guidance about the model lifecycle, implementation principles of an effective model risk model management framework, the role of management bodies and internal validation in its “Guide to internal models: General topics chapter” published beginning of 2018.
Core to supervisors’ concerns are:
- 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 Center for Regulatory Strategy
The Center for Regulatory Strategy is a source of critical insight and advice, designed to help clients to anticipate change and respond with confidence to the strategic and aggregate impact of national and international regulatory policy.
Would you like to know more about the implementation of Model Risk Management on your organisation? Please contact Koen Dessens, Harmen Meijnen or Sjoerd Kampen via the contact details below.