Model risk management continues to increase in importance, as banks rely more on models than ever. Recent global events such as the COVID‑19 pandemic have also revealed the weaknesses of our models and model risk management practices when the environment around us changes quickly.
A mature model risk management framework creates insights into the entire model landscape of a bank and across all steps of the model lifecycle, and it enables awareness and mitigation of model risk within banks. What do these frameworks look like across the different banks and what are the main challenges and next steps?
This model risk management survey was conducted between November 2020 and February 2021. A total of 80 banks across Europe, Middle East and South Africa participated in the survey. It covers all the key building blocks of model risk management across four key themes: governance, model landscape and inventory, technology, and monitoring and reporting. We hope this survey will render valuable insights into model risk management that will help banks to be responsible businesses.
The model inventory is the central repository for all models and the foundation for efficient model risk management. It contains the scope for model risk management, but is also the source for all information about model risk.
The average number of models in the inventory is around 90 models for small, 170 for medium, and 650 for large banks. It is not uncommon for large banks to have over 500 models in their inventory.
Stronger model governance across the entire model lifecycle of models is a key requirement for the model risk management framework. The role of model owner is key in model governance, and 86% of the banks indicate that they have clearly defined and documented the role of the model owner.
However, banks are facing various challenges concerning the adoption of that role. The core challenge for 35% of the banks is how to get people to act according to the responsibilities of the model owner role. For 19% of the banks, the challenge is to make people understand the responsibilities of the model owner.
The reporting structure that is used by the majority of the banks – which also evolves as a bestpractice for banks – is that of the head of model risk management reporting directly to the CRO. Another 24% of the banks indicate that the head of model risk management reports to the head of enterprise risk management, who in turn reports to the CRO.
Successful model risk management framework implementations are often supported by model risk management tooling. A valuable model risk management tool integrates the model inventory, document repository, lifecycle management and workflow, analytical and reporting capabilities into a single platform. The tool and the functionalities can greatly contribute to the effectiveness of the model risk management activities.
By far the most widely used functionality of the model risk management tooling is model inventory. According to the survey, 97% of the banks use this functionality in their tooling. Also, 65% and 57% of the banks indicate to use the functionalities of storing findings (for example validation findings, regulatory findings) and analytics and risk reporting.
Model monitoring can help to alleviate resource pressures in both model development and validation. For instance, it offers more frequent and up to date information on the quality and materiality of models, without performing periodical manual model validations or first line reviews. When model monitoring is automated, the benefits are even bigger. This results in smarter ways of working across the model lifecycle and achieves more efficient use of scarce resources.
Banks indicate that model performance, model outcomes and portfolio characteristics/stability are most often monitored. Also, 87% of the banks indicate that model monitoring for credit risk models is performed, while this is only 64% for market risk models.
Going forward, there are many areas where banks intend to enhance their model risk management framework in the next one to two years.
More than half of the banks have such intentions within the areas of analytics and reporting, the scope extension (including model in scope of the model risk management framework), model risk governance, model risk policies and standards, and standardisation of processes. Of these areas, model risk policies and standards and standardisation of processes are considered as the most challenging areas to enhance.
The results of the survey have pointed out that for most banks there are still many areas to mature and improve their model risk management framework. A mature model risk management framework can lead to more model risk awareness within banks, will help banks to tackle a growing model landscape and become a more responsible business.