Modeling has become a favored tool among banks, capital markets firms and financial services leaders, who can access a variety of advanced mathematical, statistical or numerical models to assess and manage risk. Liquidity, balance sheet and income statement scenarios all can be projected using modeling tools.
Models can help manage risk, but they come with risks of their own. Model error and model misuse can leave a bank exposed or at even greater risk.
We believe a possible solution is to establish a model risk management (MRM) framework with a focus on good governance including:
With a framework for testing models and a solid governance structure, financial providers will be better prepared to manage model risk.
A comprehensive MRM approach that addresses ownership, control and compliance involves several structural and functional steps. We believe these components are essential to helping build a reliable MRM framework:
With the right approach in place, the next steps are to evaluate and manage the models themselves. These three actions help cultivate strong models:
Model definition: Establishing what is (and isn’t) a model is a necessary first step. At their core, models have inputs, processing tools and reporting procedures. Beyond this exists some gray area that enterprises should assess thoroughly.
Risk rating and inventory: By rating risk, financial firms are prioritizing the level of review each model needs (more for high risk, less for low risk). An inventory can help firms track and prioritize their models.
Model measurement and aggregation: This new activity is still evolving, and can include model risk scorecards, assessing operational risk and evaluating model uncertainty.
Taking these steps can help banks and capital markets firms master the models in their service. Risks inherent in models will not disappear, but they will be known and tightly managed, thus supporting strong mitigation.
These new approaches are being considered
for model measurement and aggregation.
Michael Jacobs Jr, PhD, CFA
Principal Director, Accenture Finance and Risk Services
Michael has over 25 years of financial risk modeling and analytics experience in industry and consultancy.
Specialized in model development and validation for CCAR, PPNR, credit/market/operational risk; Basel and ICAAP; model risk management; financial regulation; advanced statistical and optimization methodologies.