1. Governance and oversight.
Effective governance ensures that responsibilities for model risk management are well-defined and understood throughout the organization. It involves assigning roles and responsibilities, establishing clear lines of authority, and maintaining appropriate documentation.
2. Risk identification and assessment.
This step involves identifying and assessing all relevant risks associated with the models used within the institution. It includes evaluating model assumptions, data quality, and potential limitations.
3. Data management and reporting.
Adequate data management is crucial for accurate modeling. Institutions must have robust processes for data acquisition, cleaning, and validation. Reporting mechanisms should be in place to communicate model results and insights effectively.
4. Model development, implementation, and use.
Institutions must have rigorous processes for developing, implementing, and using models. This includes model selection, development, and validation, followed by proper implementation and ongoing monitoring.
5. Documentation and validation.
Comprehensive documentation of model methodologies, assumptions, and results is essential. Additionally, models must undergo regular validation to ensure accuracy and effectiveness.
6. Monitoring and reporting model performance.
Continuous monitoring of model performance is critical to detect any deviations or issues. Institutions should establish reporting mechanisms to promptly address any model-related concerns.
7. Stress testing.
Stress testing assesses the resilience of models under extreme scenarios. Institutions must develop stress testing scenarios and evaluate how models perform under adverse conditions.
8. Internal audit.
Internal audit functions should periodically assess the institution's model risk management framework to identify weaknesses and ensure compliance with regulatory guidelines.
9. Model risk management policies and procedures.
Having well-defined policies and procedures in place is crucial to guide the institution in managing model risk effectively. These documents should cover all aspects of model risk management.
10. Board and senior management oversight.
The board of directors and senior management play a pivotal role in overseeing model risk management activities and ensuring they align with the institution's overall risk strategy.
