Model risk is the potential for adverse consequences from incorrect or misused model outputs and reports using these outputs. Model risk can lead to financial loss, poor business or strategic decision making, or damage our reputation. The term ‘model’ refers to a quantitative method, system, or approach that applies statistical, economic, financial, or mathematical theories, techniques, and assumptions to process input data into quantitative estimates.
Model risk is managed across Pricing models, Risk & Capital models, and other models:
- Pricing models are used to generate asset and liability fair value measurements reported in official books and records and/or risk sensitivities which feed Market Risk Management (MRM) processes;
- Risk & Capital models are related to risks used for regulatory or internal capital requirements, e.g. VaR, IMM, Stress tests etc.;
- Other models are those outside of the Bank’s Pricing and Risk & Capital models.
Model risk appetite is aligned to the Group’s qualitative statements, ensuring that model risk management is embedded in a strong risk culture and that risks are minimized to the extent possible.
The management of model risk includes:
- Performing robust independent model validation that provides effective challenge to the model development process and includes identification of conditions for use, methodological limitations that may require adjustments or overlays, and validation findings that require remediation;
- Establishing a strong model risk management and governance framework, including senior forums for monitoring and escalation of model risk related topics;
- Creating Bank-wide model risk related policies, aligned to regulatory requirements with clear roles and responsibilities for key stakeholders across the model life cycle; and
- Providing an assessment of the model risk control environment and reporting to the Management Board on a periodic basis.