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