Model Risk
Nowadays companies use a wide range of mathematical, statistical, and expert models to support their business operations. However, the use of models also involves certain risks — if a model functions incorrectly or if its outputs are misinterpreted, it may lead to significant financial losses caused by poor decisions (based on information provided by the model). The potential loss associated with the use of models is generally referred to as model risk. Due to the increasing influence of models on many various processes, model risk, its identification, measurement and management are topics of growing importance. The requirements for implementation of a model risk management system are often formulated by owners or management of a company, or in banking industry by regulators.
ARM would like to offer you consultancy services aimed at model risk management and related areas.
Our services include:
Design/Assessment of Internal Methodology for Model Risk Management
We will help you develop an internal methodology for model risk management, which will typically include the following components:
- definition of what is understood as a “model”,
- classification of models (specification of model type),
- definition of model risk management procedures throughout the model lifecycle for individual types of models,
- setting of rules and criteria for assessing:
- relative importance of every used model (in terms of size of portfolio, type and frequency of supported activity, etc.),
- quantitative impact of model errors (e.g., quantification of probability of error, average loss impact of an error and expected number of applications)
- size of model risk for individual types of models,
- definition of limit values for individual criteria (e.g., in terms of “traffic light system” for managerial decisions) and list of possible corrective measures,
- model governance framework, especially the definition of roles and responsibilities,
- setting of reporting rules.
Specialized Workshops and Ad-Hoc Consultations During the Preparation of Model Risk Management Methodology
- Introducing possible approaches to model risk identification, measurement and management
- Discussion of specific tasks in terms of client’s models
- Clarifying the regulatory requirements (if any)
- Providing comments and expert opinion during the methodology preparation
Technical Support for the Implementation of Software Supporting Model Risk Management
We provide the following services in the area of technical support related to:
- procurement and implementation of an existing software solution:
- assistance in preparing a checklist describing the minimum requirements for software operation and the required functionalities,
- preparation of a functional specification for features not included in the delivered solution,
- support for project management,
- or development of a tailor-made software solution:
- preparation of a detailed functional specification of the software with the following objectives:
- smooth software development,
- compliance with the established project timeline,
- inclusion of all required functionalities (e.g., workflows related to model development, validation, approval, implementation, testing, and use; collection of related model documentation),
- transparent management of the tool’s development process (e.g., programmers fully understand the technical requirements and do not need to understand the internal logic of risk management; the client’s experts have a clear basis for monitoring the developed functionalities),
- preparation of test scenarios (user testing),
- execution of user testing scenarios,
- support for project management.