Model Risk Management

Models have become a commonly used mode of decision-making by businesses. Advanced analytics techniques are being used to create even more complex models in the present times; but the question is: what is a model? A model is a quantitative and mathematical system that helps businesses process input data.

What is model risk management?

Model risk management is the system that oversees the potential risks that might arise out of a faulty or misused model. The aim of this management system is to identify, measure, and mitigate models risks. Banks, insurance companies, and other financial institutions use models to run their operations on a daily basis, and this is where an enterprise risk management model becomes crucial.

With advanced analytics and the association of these financial institutions with big data, various sophisticated models like customer relationship management or fraud detection have become popular. Companies are now investing millions into model risk management training to protect themselves.

Let us explain the importance of such a model with an example. In a 2012 NYTIMES article, J.P. Morgan was faced with a loss of over $6 billion due to the lack of governance and failure of a credit model. This incident has come to be known as the London Whale Trading Incident in the world of finance. Many more such incidents over the last decade have led to a dire need for supervised and regulated model risk management. These institutions also have to possess certain model risk management certifications as per the rules.

What is the potential value of a mature MRM?

A mature MRM framework has the potential to increase the earnings of an institution or business by avoiding losses, reducing costs, and improving capital. Losses can be avoided and costs reduced by increasing the efficiency of operations and other processes. Successful MRM models can improve capital by the reduction of add-ons. However, when a company notices that its MRM framework is not working properly, they generally request add-ons.

What are the four pillars of model risk management?

Any organization must first build a model risk management framework to effectively manage model risks. In this enterprise risk management model framework, different people are allocated different jobs and duties that encompass the pivotal pillars of risk management. For managing the duties, institutions also undergo severe model risk management training programs to upskill people for better functionality. So, what are the four pillars of the risk management framework?

  • Model risk identification and assessment wherein companies try to figure out what the model is exactly.
  • Model risk governance to regulate the system
  • Model risk validation for measurement and mitigation by checking data, conducting backtests, performing benchmarks.
  • Model monitoring and reporting to supervise what is happening in the production.

Model risk management training includes teaching employees these pillars and how to make the best decisions when it comes to implementing certain practices for financial institutions. There are training institutions that provide courses on quantification of model risk, how to measure model risk in AI/ML models, and so on.

Model Risk Management Certification

In this last section of the article, we discuss some model risk management certifications that risk managers can get to be considered qualified for the job. These include the Certified Risk Manager (CRM) certification offered by TNA, the Associate in risk management by the Institutes, the Certified Professional in Health Risk Management certification offered by American Hospital Association, the Project Management Professional certification offered for risk management directors, and many more.

To sum up

Model risk management has become a hot topic over the last couple of years due to its necessity in financial institutions like banks and insurance companies. This article will help you navigate the basics of this framework along with certain other details about model risk management training and certifications.