I attended model risk management conference organized by PRMIA
It was a very generic conference on Model Risk management not focused towards any specific agenda. I would like to list out key points which were talked about:
- Documentation of model is key challenge for model risk. There are many reasons of lack of proper documentation of models, namely:
- Model developers are quants and are not interested in documenting their models because this is not interesting for them.
- Business owners are do not want to document their business activity that translates into model because they do not want to disclose their business strategies. Once they document them then those strategies will be on public domain.
- There should be a specific team whose responsibility is documentation.
- The panel stressed the importance of translators. These are those people who understand business, quants and IT aspects. So they will co-ordinate with these respective teams and hence limit model risk.
- This will give rise to the role of consultants.
- Model risk rise due to lack of understanding of the ecosystem. When two banks merge, in addition to merging of balance sheets they should also merge the models. There was an incident where two banks were merged and its two divisions were selling a derivative at two different prices. The raised an opportunity of making arbitrage within the bank.
- It is observed that when the banks fail a regulatory test (CCAR) they make huge investments in hiring quants for model development and model validation. Ideally they should hire more business professionals who can understand their business and streamline their processes. This streamlining will help in robust model development and hence limit model risk.
- Model risk also arises because lack of questions being asked by the risk managers when they receive the risk numbers from the business. There needs to be a cultural shift where risk managers should insist on explanation from the business on the numbers they provide.
- Ongoing monitoring is very important in aspect to check model risk. Best practices need to be developed to handle these processes. Banks can:
- Automate the whole process: This will give risk to new model risk.
- Transfer the process to countries where cost of low.
- Prepare dashboards which alerts the stakeholder in case the model is performing not on expected lines.
- Irony is that banks invest in risk management when they fail regulatory test and not when they pass giving rise to model risk.
I have opinion on one point: Business owners being afraid in disclosing their strategies.
Being in business because you have a secret sauce with respect to your business is a thing of past now. Winners will be those who understand their customers well.
Date: Oct 16 2016
Interesting article by the speaker: