Model risk management (MRM): Banks underestimate the risks of inadequate model governance

Financial institutions (FIs) have used models for corporate governance and key aspects of the business for decades. The importance of models continues to increase in the course of digitalisation. At the same time, model risk management (MRM) has evolved in recent years as a result of continuously increasing regulatory requirements. It is therefore both business requirements and regulatory requirements that cause FIs to pay more attention to MRM.

The recent increase in market volatility and current macroeconomic trends mean that models used to date are reaching their limits, model weaknesses are becoming visible and a good MRM is more important than ever. Last but not least, new technologies, such as artificial intelligence and machine learning, bring additional opportunities, as well as new challenges in dealing with models that a good MRM adequately considers.

“Some financial institutions have suffered significant financial losses and reputational damage due to inadequate practices and standards in relation to model development and use. Model risk is real, and the consequences of poorly calibrated or unsuitable models can be far-reaching,” says Haie Lawrenz, Senior Manager at KPMG Germany and member of the Global Model Risk Working Group.

Although most FIs have understood how much their future business success depends on an appropriate MRM framework, its implementation is a major challenge for many FIs due to its complexity and dependencies.

“The control and management of model risks is of great importance. An important aspect is good model governance that regulates regular checks, model design, model development, handling of model changes and the application of models,” says Matthias Peter, Partner at KPMG Germany and Head of the Global Model Risk Working Group.

To help FIs establish a holistic MRM framework, with our global colleagues, we have developed MRM market practices that enable both regulatory compliance and good MRM in terms of managing business risk.

Our English-language publication “Increasing Challenges for Model Risk Management (MRM) within Financial Institutions” outlines the key steps to building an effective and efficient MRM framework in FIs.

You can download the white paper here: