On 30 April 2018, the PRA published Supervisory Statement 3/18: Model risk management principles for stress testing (SS3/18). SS3/18 is relevant to PRA authorised banks, building societies and PRA-designated investment firms. Credit unions are not in scope and there is currently no proposal to extend it to insurance and reinsurance firms.

In SS3/18 the PRA sets out its expectations as to the model risk management practices firms should adopt when using stress test models. It supports firms’ development and implementation of policies and procedures to identify, manage and control the risks inherent in the use of stress test models.

The PRA’s model risk management principles for stress testing are centred on four key principles:

  • Principle 1 – Banks have an established definition of a model and maintain a model inventory;
  • Principle 2 – Banks have implemented an effective governance framework, policies, procedures and controls to manage their model risk;
  • Principle 3 – Banks have implemented a robust model development and implementation process and ensure appropriate use of models; and
  • Principle 4 – Banks undertake appropriate model validation and independent review activities to ensure sound model performance and greater understanding of model uncertainties.

The PRA has adopted a proportionate approach and expects the larger firms that participate in the Bank of England’s (the BoE) annual concurrent stress testing to apply the principles in SS3/18 in full, while firms not participating in the BoE’s annual concurrent stress testing should apply the principles on a proportionate basis, taking into account their size, complexity, risk profile and the relevance to them of stress test models.

SS3/18 takes effect from 1 June 2018.