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Regulatory Expectations for Model Risk Management

November 2024

On 18 August 2022, the Office of the Comptroller of the Currency (OCC) published its model risk management (MRM) chapter of the Comptroller’s Handbook in OCC Bulletin 2021-39 (2021 Handbook). The 2021 Handbook presents the concepts and general principles of model risk management and provides guidelines for examiners in planning and conducting examinations on model risk management, i.e., a view on the expected approach to model risk supervision.

While it doesn’t supplant the 2011 Supervisory Guidance on Model Risk Management OCC 2011–12 (issued by the Federal Reserve as SR 11-7), the 2021 Handbook highlights its key elements and provides supplementary explanations, as well as significant additional interpretations and clarifications. The expansion of the 2011 guidance represents the evolution of model risk management examination practices consistent with industry developments and interim OCC issuances.

Prudential Regulation Authority (PRA)'s policy statement PS 6/23 on model risk management aligns closely with SR 11-7. Most of the statement below apply to PS 6/23, especially with respect to AI-based models.

Key takeaways:

Scope and model definition. Clarifies the definition of a model and expectations surrounding appropriate governance of non-model analytical tools. It emphasizes applying the appropriate level of risk management activities regardless of whether an analytical tool meets the bank’s definition of a model.
Risk-sensitive MRM. Emphasizes tailoring of risk management activities a model’s risk level to determine the breadth, depth, priority and frequency of MRM activities.
Risks associated with model use. Explains how use of models can increase other types of risk (e.g., credit or market) and outlines the approach to incorporate model risk into assessments for other types of risk.
Risk management of artificial intelligence (AI) models and non-models. Emphasizes the need for appropriate risk management when using AI, the risks of which can be high depending on the complexity of the methodology and its use. Special emphasis is made on analyzing the potential for bias.
The role of MRMs in fair lending. Emphasizes the important role that MRM has in a firm’s fair lending program and lays out detailed expectations on fair lending considerations in a bank’s MRM framework.
Third-party risk management considerations. Provides a detailed discussion of TPRM considerations, largely reflecting the 2020 FAQ on third-party relationships. Also, it offers explicit references and important clarifications in the treatment of vendor-funded validations and how a bank might use them in reviewing vendor models.

Overall, the publication of the handbook signals the importance that supervisors place on MRM, given the growing importance of models and the risks associated with the growing use of artificial intelligence. The evolved approach to MRM focuses on the adequacy of risk management controls regardless of whether an analytical tool is formally classified as a model. It provides a useful guide for banking organizations to assess and strengthen their MRM programs.

Read the previous longer version of this insight on IBM Promontory Blog.

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