On 21 June 2022, the Prudential Regulation Authority (PRA) published Consultation Paper 6/22 ‘Model risk management principles for banks’ (CP6/22). In CP6/22 the PRA sets out its proposed expectations regarding bank’s management of model risk. The PRA has developed a proposed set of five principles (see below), which it considers to be key in establishing an effective model risk management (MRM) framework. The principles are intended to complement existing requirements and supervisory expectations in force on MRM and would be set out in a supervisory statement.
The proposed principles cover all elements of the model life cycle and would be applicable to all types of models that are used to inform key business decisions, whether developed in-house (including vendor models) and models used for financial reporting purposes.
The proposed principles are:
- Principle 1 – Model identification and model risk classification: Firms have an established definition of a model that sets the scope for MRM, a model inventory, and a risk based tiering approach to categorise models to help identify and manage model risk.
- Principle 2 – Governance: Firms have strong governance oversight with a board that promotes an MRM culture from the top through setting a clear model risk appetite. The board approves the MRM policy and appoints an accountable individual to assume responsibility to implement a sound MRM framework that will ensure effective MRM practices.
- Principle 3 – Model development, implementation and use: Firms have a robust model development process with standards for model design and implementation, model selection, and model performance measurement. Testing of data, model construct, assumptions, and model outcomes are performed regularly in order to identify, monitor, record, and remediate model limitations and weaknesses.
- Principle 4 – Independent model validation: Firms have a validation process that provides ongoing, independent, and effective challenge to model development and use. The individual or body within a firm responsible for the approval of a model ensures that validation recommendations for remediation or redevelopment are actioned so that models are suitable for their intended purpose.
- Principle 5 – Model risk mitigants: Firms have established policies and procedures for the use of model risk mitigants when models are under-performing, and have procedures for the independent review of post-model adjustments.
The deadline for comments on CP6/22 is 21 October 2022.
The PRA proposes that the implementation date would be set at 12 months following the publication of the final supervisory statement.