Model Risk Management Explained

What Is Model Risk Management?

Financial institutions like banks and bank holding companies use models to simulate a variety of financial situations and market conditions. The goal of financial modeling is to determine what conditions a certain investment, portfolio, or business process can no longer operate under effectively. Models used for budgeting, determining event probabilities, analyzing financial statements, and examining product pricing are often exceedingly complex, and therefore carry risk.

Model risk management refers to the potential for adverse consequences from decisions based on incorrect or misused outputs and reports. With technological advances, increasing regulatory requirements, and various other internal and external forces, models have been increasing in both number and complexity. This increase has resulted in a greater need for proper model risk management, or the process of identifying, assessing, and mitigating these risks.

What are the Benefits of a Model Risk Management Framework?

With the number of models rising 10 to 25 percent annually at large institutions, model risk management frameworks are quickly becoming a necessity. Aside from growth in areas such as stress testing for regulatory requirements, there has been a dramatic increase in the reliance on modeling for making critical business decisions. Mismanagement of model risk can lead to dramatic financial losses, poor business and strategic decisions, or even damage to a bank’s reputation.

The benefits of adopting model risk management software are therefore numerous. Not only can model risk management prevent losses from occurring, it can also boost earnings by identifying potential cost reduction or capital improvement options. A robust model risk management framework can streamline the development, validation, and governance of financial models, which in turn protects financial organizations from adverse risk events and reputational turmoil.

LogicManager’s Model Risk Management Software

The Federal Reserve and Office of the Comptroller of the Currency issued Supervisory Guidance on Model Risk Management, which is intended for use by banking organizations and supervisors as they assess organizations’ development and use, validation, and governance of financial models. LogicManager’s model risk software empowers organizations to meet these guidelines.

• Document model development decisions in one centralized platform

• Assign accountability to relevant personnel with automated tasks and notifications

• Objectively assess model risk across the enterprise with pre-built risk assessments

• Enhance the accuracy of reporting with ready-made model risk reports and dashboards

• Track issues and remediation tactics with incident reporting capabilities

• Engage the board, senior management, and internal audit teams in the review and validation process