Models are increasingly important tools that financial institutions use to measure and manage risk. The Basel III Accord introduced a new, comprehensive framework for model risk management (MoRM) that requires banks to put in place robust processes for validating their models’ accuracy and reliability. In this blog post, we’ll give an overview of the key components of the Basel MoRM framework.
The Basel Committee on Banking Supervision’s (BCBS) “Sound practices for model risk management” document provides guidance on how banks can develop an effective MoRM framework. The key components of the framework are:
- A model inventory that includes all types of models used by the bank, their purpose, and their owner.
- A model risk policy that outlines the bank’s approach to managing model risk, including responsibilities, governance, and controls.
- A model development process that ensures models are fit for purpose and meet all technical requirements. This includes validation activities such as backtesting and sensitivity analysis.
- An ongoing monitoring program to identify and mitigate model risk on an ongoing basis. This should include regular reviews of model performance and updates to the model development process as needed.
- A incident reporting process for when issues with models are identified. This should include root cause analysis and corrective action plans.
The Basel III Accord introduced a new, comprehensive framework for model risk management (MoRM) that requires banks to put in place robust processes for validating their models’ accuracy and reliability. In this blog post, we’ve given an overview of the key components of the Basel MoRM framework. By understanding the requirements of the MoRM framework, banks can develop an effective MoRM system that will help them manage risk more effectively.
