Cover
RAPPORT

Model Risk Management

White paper

Models are an integral part of modern banking. They are used inter alia to price transactions, value portfolios and optimise returns. They are also a key cornerstone of the regulatory framework, used to determine required capital and liquidity.

Models, however, require constant vigilance and scepticism. Risk measurements and financial analytics always need to be monitored for effectiveness and relevance. The simplification and assumptions that models must necessarily employ sometimes come at the cost of accuracy and structural integrity under stress. This exposes the bank to model risk: the risk of economic or reputation loss due to errors in the development, implementation or use of models.

In this paper, we set out the key cornerstones of a modern model risk management framework. We start with an overview of the regulatory (i.e., mandatory) requirements, but then consider in greater detail other aspects of the framework, in particular those where some element of management discretion remains. We set out our view of the challenges and emerging best practice, illustrated where possible with anonymised anecdotes from financial institutions.

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