MRM framework and Model Tiers

​Although many institutions in the UK are progressing towards attaining a certain standard in MRM practices, the rate of progress is uneven and unfortunately so are the ambition levels.
 
It is critical therefore to start with the correct understanding of the essential building blocks for an effective MRM framework as identified below:
 

• Policies and Documents
• Stakeholder Management
• Model Inventory and Tiering
• MRM Processes and Lifecycle Management
• Model Monitoring and Reporting

 
Figure 01 – Buildings blocks of an effective MRM Framework

Model Tiering and Risk Classification
In order for any institution to have a successful MRM Framework, it will need to have a standardised model tiering procedure.
 
The assigned model Tier will dictate all model related processes:

• Rigour of the pre-implementation validation
• Frequency and rigour of ongoing performance monitoring
• Frequency and rigour of periodic validations
• Model approval process (for both new model and model iterations)

 
All models should have an assigned tier / risk classification, based on:

• Model type (i.e. regulatory or non-regulatory)
• Complexity
• Financial Impact (from model error or misuse)
• Reputational Impact (from model error or misuse)

 
Figure 02 Model Tiers                     ​

Note(s): 
*Pillar-1 Risks are Credit, Market & Operational Risk. Pillar-2 risks are residual risks after accounting for Pillar-1 risks- refer BCBS128 for details on Pillar-1 and Pillar-2 risks.
**Assess the model materiality, quantitatively and qualitatively. Quantitative Materiality of the models is calculated as the percentage impact on the institutions relevant financial portfolio. Qualitative Materiality is subjective and dependant on both regulatory and customer expectations.

The Tiering methodology should be segmented between a ‘Preliminary’ and ‘Final’ decision, and the process will ideally include both 1LOD and 2LOD stakeholders:
 
Figure 03 Model Tiering Methodology                      ​

​Once you have a clear understanding of the framework and have deployed models, it is essential to properly monitor the model for as long as it is in use to gain maximum benefit and stay in control. I will talk about this in my next article.

If you wish to discuss any of the points raised or are interested in finding out how we can help you review or implement your own MRM and Model Governance framework, please contact us here to book your free Discovery consultation.

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Sources:
Risk.net MRM report (Risk_MRM_0719.pdf) – slide 9.
Deloitte (MRM_Risk_Ldn_01_MRM_Landscape_Sjoerd_K_Deloitte.pdf) – Model risk management building blocks and industry insights, slide 10.

Brendan Jayagopal

Founder and Managing Director. Blue Label Consulting