On 17 May 2023, the Prudential Regulation Authority (PRA) published Policy Statement PS6/23, ‘Model risk management principles for banks’, which contains a new supervisory statement (SS1/23) on the topic, as well as the PRA’s feedback to responses to its earlier consultation CP6/22.
SS1/23 sets out the PRA’s expectations for banks’ management of model risk, with the aim of encouraging banks to take a strategic approach to model risk management (MRM) as a risk discipline in its own right. The expectations are set out in the form of five principles considered key to implementing a robust MRM framework and managing the risk effectively across all model and risk types. These principles are intended to support firms to strengthen their policies, procedures, and practices to identify, manage, and control the risks associated with the use of models.
The themes of the principles are:
- Principle 1: Model identification and model risk classification.
- Principle 2: Governance.
- Principle 3: Model development, implementation and use.
- Principle 4: Independent model validation.
- Principle 5: Model risk mitigants.
The principles are supported by sub-principles, which include:
- A proportionate implementation within firms (across models) and across firms.
- The identification and allocation of the responsibility for the overall MRM framework to the most appropriate Senior Management Function (SMF) holder(s).
- Reporting on the effectiveness of MRM for financial reporting to the audit committee.
- Identifying and managing the risks associated with the use of artificial intelligence in modelling techniques such as machine learning to the extent that it applies to the use of models more generally.
The expectations in SS1/23 apply to firms with internal model approval to calculate regulatory capital requirements.
The policy will take effect on 17 May 2024. Firms that first receive permission to use an internal model to calculate regulatory capital after the publication of PS6/23 will have 12 months from the grant of that permission to comply with the expectations in SS1/23.