MANAMA: Recent market volatility and macroeconomic trends demand a significant change in the business, risk, compliance models used by banks, according to KPMG experts.
According to Angshuman Dey, a technical director for financial risk management with KPMG in Bahrain, realising the need for a strategic change management process built around strong governance, financial institutions are looking to facilitate effective implementation and compliance with model risk management (MRM) standards.
This stems from the fact that this could alter and impact the model outcomes, he added.
Inadequate practices and standards regarding model development and usage has led to widespread attention and exposure while also facilitating sub-optimal lending decisions, and pricing that can impact financial performance.
This then may lead to a domino effect on steering parameters of financial institutions, including profitability, operational efficiency and capital requirements.
This is evident across models covering credit risk, market risk or operational risk, and even include models enhanced by machine learning (ML) and artificial intelligence (AI).
“The global financial crisis showed us that model risk is real and that the consequences can be far-reaching. In the past some banks have suffered from significant financial and reputational damages due to the use of uncalibrated models or the use of inappropriate models to address considered risks,” said Haie Lawrenz, a member of KPMG’s Global Model Risk Management Working Group.
“Additionally, the importance of models for business decisions have increased significantly as we see the inclusion of AI and ML models in the new digital business models and sales channels.”
Regulators meanwhile are intensifying their focus on Model Risk Management (MRM), with regulatory inspections and exams connected to MRM increasing and regulators publishing new guidance.
“We are experiencing an increasing demand in stakeholder expectations which is driving a positive impact on risk management. Regulators, shareholders, and board members around the world are pushing for an increase in sophisticated risk management protocols across at an enterprise level covering capital, liquidity, and even credit and cost forecasting. Regulatory attention on this matter is accelerating the level of guidance provided to FIs to help them drive progress towards a more effective and efficient model validation value chain,” said Mahesh Balasubramanian, partner and financial services lead at KPMG in Bahrain.
Forward-focused financial institutions have already embraced the concept of MRM, and realise its critical importance to their operations, growth and future prosperity.
However, we are still witnessing many FIs struggle to meet the complexities and challenges posed by the regulators, particularly in relation to the typical model approaches and the diversity of the environments in which models are used.
MRM is still significantly underappreciated which has led to the risk of many FIs developing short term solutions with limited strategic benefit and scope.
Emerging technology and AI are taking MRM to the next level and is rapidly becoming a steady feature in digital sales channels for various client and sales channel applications.
However, many banks lack even basic MRM governance exposing themselves to significant operational and financial model risk, the experts said.
MRM not managed is a real threat for financial institutions and the impact from the risks can be far-reaching.
Mr Lawrenz further adds that: “Based on regulatory requirements highlighted in a current regulator’s guidance and consultations, many banks are struggling to meet their mandate and need to urgently prepare and enhance their MRM governance to ensure that they are not impacted by their exposure to model risk as well as any regulatory gaps within their models or MRM-framework.”
Additionally, MRM is an emerging risk, especially for audit committee members, as banks increasingly rely on a significant number of models for business and risk management purposes.
avinash@gdnmedia.bh
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