Model risk management (MRM) is a process designed to identify, measure, monitor, and manage the risks associated with models used in financial institutions. This process should include policies for MRM objectives and scope, the models themselves, and the management of model risk through the model life cycle. Implementing an effective model risk management program can be a complex task; however, it is essential that all areas of the organization are aware of their responsibilities. Let’s take a closer look at how to get started building your initial phases of a model risk management program.
Step 1: Establish MRM Objectives and Scope
The first step in developing an effective MRM program is to establish clear MRM objectives and scope. This includes understanding the types of models used by the organization and defining what “model risk” means to the organization. The objectives should also set out clearly defined roles and responsibilities for each team member involved in managing model risk.
Step 2: Identify Your Models
Once you have established your MRM objectives and scope, you will need to identify all models used by your organization. This includes any models used for forecasting or decision making in areas such as finance, accounting, marketing, operations, etc. You should also consider any third-party models that may be used within your organization. Once you have identified all of your models, you will need to assess each one individually based on factors such as accuracy and reliability. The goal here is to understand how each model works so that you can determine its potential risks as well as its benefits.
Step 3: Manage Model Risk Through the Model Life Cycle
The final step in building an effective model risk management program is managing model risk through its entire life cycle – from development through implementation and maintenance. This includes regularly reviewing each model’s performance over time to ensure accuracy and reliability remain high throughout its lifespan. Additionally, it’s important to document any changes made to the models during their life cycle so that everyone involved can stay up-to-date on their status at all times.
An effective model risk management program is essential in ensuring accuracy and reliability across all areas of a financial institution’s operations. Establishing clear objectives and scopes for MRM helps define roles and responsibilities among team members while identifying all applicable models provides insight into potential risks associated with them. Finally, proper management through the entire life cycle ensures accuracy remains high throughout all stages of development, implementation, maintenance, etc., reducing overall organizational exposure to loss due to inaccurate or unreliable data inputs or outputs from these systems over time. Ultimately this enables organizations to better serve their customers by providing reliable data inputs into decision-making processes which lead to optimal outcomes for everyone involved.
