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Model risk

Back in April, the Prudential Regulation Authority (PRA) published its Supervisory Statement (SS 3/18), setting out its expectations as to the model risk management practices that firms should adopt when using stress test models.

The PRA’s model risk management principles for stress testing are centred on four key principles:

  • Firms should have an established definition of a model and maintain a model inventory.
  • Firms should have an effective governance framework, policies, procedures and controls to manage their model risk.
  • Firms should have a robust model development and implementation process to ensure appropriate use of models.
  • Firms should undertake appropriate model validation and independent review activities to ensure sound model performance and greater understanding of model uncertainties.

In the following articles we explore what each of the principles mean and more importantly what the pitfalls are and how you can make sure you don’t fall foul of the regulator.

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Model risk in stress testing

PRA supervisory statement on model risk in stress testing for financial services organisations. How can you comply, what are the principles and what do you need to do?
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Principle one

Banks have an established definition of a model and maintain a model inventory | What does principle one mean for you, and what do you need to do?
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Principle two

Firms should have an effective governance framework, policies, procedures and controls to manage their model risk | At all levels of the organisation, those involved in creating, using, overseeing and controlling models have a part to play - where do you fit in? 
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Principle three

Banks have implemented a robust model development and implementation process to ensure appropriate use of models | Have you got a robust model development and implementation process and can you demonstrate it to the regulator? 

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Principle four

Banks undertake appropriate model validation and independent review activities to ensure sound model performance and greater understanding of model uncertainties | As with the other three principles, the PRA gives sound, common sense guidance overall but leaves a lot of practical matters untouched and questions unanswered. 

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