Finance Monthly - August 2023

In fact, regulation around model risk management processes is already becoming more stringent, with the Prudential Regulation Authority (PRA) having recently directed UK banks to improve model and data governance processes through the introduction of new model risk regulation. The Supervisory Statement SS1/23 highlighted the fact that UK banks were lagging behind international peers when it came to ‘effective and robust’ model risk management (MRM). Not only did this leave them open to damaging losses, inaccuracies could have an impact on the overall stability of the UK economy. With this in mind, the new proposed standards contain five key principles that have been designed to reduce the probability and severity of future crises in the financial sector. Covering model identification and model risk classification, firms must have an established definition of a model that sets the scope for MRM, a model inventory, and a risk-based tiering approach to categorise models to help identify and manage model risk. There is also a focus on good governance, with firms required to promote good MRM culture from the top down, setting clear model risk appetite, approving the MRM policy and appointing an accountable individual to be responsible for implementing a sound MRM framework. Alongside this, firms must have a robust model development process with clear standards for model design, implementation, selection and performance measurement. Given the volatility of the market and challenging economic backdrop, firms will also be required to regularly test their data, model construct, assumptions and outcomes - key processes that will help to identify, monitor, record, and remediate any limitations and weaknesses within the models. In addition, the PRA has introduced independent model validation to ensure that recommendations for remediation or redevelopment are actioned as quickly as possible so that models are suitable for their intended purpose. Should models be under-performing, firms also need to take quick action, often in the form of an independent review to ensure that they are working effectively. Taking action SAS works with organisations across all aspects of the financial services sector, having partnered with over 80 banks to implement robust MRM processes. Given the rapidly changing environmental and digital landscapes, as well as the aforementioned increasing use of AI and sophisticated modelling techniques, now is undoubtedly the time for firms to adopt a more strategic approach not only to MRM but all model management. As we have seen recently with The Bank of England coming under fire, inadequate or flawed design and implementation of models can lead to adverse consequences that pose significant risks to both their own financial stability and the overall economic stability of the UK economy. “Aside from the external factors that have made forecasting more challenging, namely the global pandemic and war in Ukraine, rapid advances in technology have also raised questions.” Finance Monthly. Banking & Financial Services 37

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