Model risk management (MRM) is the practice of identifying, assessing, and managing risks that may arise from the use of models. A model is a mathematical representation of real-world data or events. Models are used in a variety of industries, including banking, insurance, investing, and manufacturing.
The goal of model risk management is to ensure that models are accurate and reliable, and that they produce the intended results. Model risk can arise from many sources, including model misspecification, errors in data input, and incorrect assumptions. left unmanaged, model risk can lead to financial losses, legal liabilities, and reputational damage.
Why Model Risk Management Is Important
Model risk management is important because it helps organisations avoid losses and protect their reputation. When done correctly, model risk management can also improve decision-making and result in cost savings. Additionally, model risk management can help organisations meet regulatory requirements related to the use of models
The Basel Accords require banks to have robust processes for identifying and managing model risk. In the United States, the Office of the Comptroller of the Currency (OCC) has issued guidance on model risk management for national banks and federal savings associations. The OCC’s guidance includes principles for effective model risk management practices, such as clearly defining roles and responsibilities related to models and establishing an independent model review function.
Model risk management is a practice that is used in order to identify assess and manage risks which may occur from the utilization of models. It is essential because it helps organizations protect their assets as well as their reputation while also promoting better decision making abilities overall. Furthermore, it meets regulatory requirements that have been put into place surrounding the use of models in different industries such as banking or insurance. Consequently, if your organization uses models you should have a plan for model risk management in order to avoid any potential disasters that could ensue without one.
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