Transcription of Model Risk Management - Deloitte US
1 Model Risk ManagementDriving the value in modellingApril 2017, Risk Advisory 2017 Deloitte Conseil2 AgendaCONTEXT 1 APPENDIX 6 CONTEXTMRM CONTENTSDELOITTE MRM OFFERCONTACTSAPPENDIXCREDENTIALS 2017 Deloitte Conseil3 Part 1 ContextCONTEXTMRM CONTENTSDELOITTE MRM OFFERCONTACTSAPPENDIXCREDENTIALS 2017 Deloitte Conseil4 CONTEXTMRM CONTENTSDELOITTE MRM OFFERCONTACTSAPPENDIXCREDENTIALSHow important is Model risk ? Model risk may be particularly high, especially under stressed conditions or combined with other interrelated trigger Morgan The London WhaleImpacts:thebankmadelossesof 6bnandwasfined 1bnWhathappened?Thebank sChiefInvestmentOfficerwasresponsiblefor investingexcessbankdepositsinalow-riskma nner.
2 Tohedgeagainstpossibledownturnsintheecon omy,theCIOboughtsyntheticCDSderivatives. Initiallyintendedasanhedgingstrategy,thi sportfoliobecamea speculativesourceofprofitandincreasedfro m$4bnin2010to$ , modelriskinvolved?Insteadof scalingbacktherisk, thespreadsheetusedforthatpurposeandtheri skwasunderstatedby50%.Thiserrorenabledth eportfoliotocontinuegrowing, Arbitrage investment strategiesImpacts:thehedgefundlost$ ,depletingalmostitsentirecapitalWhathapp ened?Thehedgefundwasestablishedbyrenowne dbondtradersandthemainshareholdersinclud edNobelprize-winningeconomists(MyronScho lesandRobertMerton).Investorsconsistedin highnetworthindividualsandin ,involvinghedgingagainstarangeofvolatili tyinforeigncurrenciesandbonds, Atonepoint,thenotionalvalueof thederivativepositionwas$ WhentheRussiancrisiskickedoffin1998, / MBS 2007 subprime mortgage crisisImpacts:oneofthemaincauseandsource oflossesinthe2007financialcrisis.
3 As -ofSept. 2008, bankwrite-downsandlossestotaled$ AAAratingtoa significantportionofsecuritiesbackedbypo olsofloansincludinga significantproportionofloanstohomebuyers withbadcreditandundocumentedincomes(subp rimemortgageloans)Howis modelriskinvolved?Between2002and2007,the mortgageunderwritingstandardshadsignific antlydeteriorated. , ,a significantportionofAAACDOandMBStranches werefinallydowngradedtojunkin2007andearl y2008,oncethehousingbubbleburstin 'creditratingswereinfluencedby"flawedcom putermodels,thepressurefromfinancialfirm sthatpaidfortheratings,therelentlessdriv eformarketshare,thelackof resourcestodothejobdespiterecordprofits, andtheabsenceof meaningfulpublicoversight.
4 Market risk regulatory pre-crisis modelsImpacts:theVaRmetricsusedbeforethe outburstof thefinancialcrisisdidnotadequatelycaptur etail-riskevents, ,essentiallydrivenbycreditriskevents,a largenumberofbanksposteddailytradingloss esmanytimesgreaterthantheirVaRestimatesa ndquitefrequentlyduringthatperiod,in a (assumingmarketliquidityandlargediversif icationeffectsacrossassetclasses,etc.). Inaddition,tailcreditriskeventswerenotad equatelymodelled,henceunderestimatingpos siblelossesin stressedconditions. 2017 Deloitte Conseil5 Main regulatoryreferenceson MRMW hatabout the future regulatoryframework?BCBS 2004-06 Valuation adjustments [..] where appropriate, Model CEBS GL 10 New Validation RequirementsBCBS 2010-11 Introduction of a Leverage Ratio as a safeguard against Model RiskOCC 2000-16 First Definition of models and Model riskBank IT Circular 285/2013 Management Body must understand all of the business risks .
5 Including Model of 3 lines of defenceBank of Spain 2008-14 Banks need to consider valuation adjustments for Model RiskOCC-Fed 2011-12SR - 11 - 7 First Supervisory Guidance on MRMEBA RTS 2013 on Prudent ValuationValuation adjustments on MR QuantificationCRD IV/CRR 2013 36 Technical criteria concerning the organisation and treatment of risksEBA SREP CP/2014/14 Integration of Model Risk as part of Pillar IISSM, EBA, ECB to focus their regulatory efforts on Model Risk Management CONTENTSDELOITTE MRM OFFERCONTACTSAPPENDIXCREDENTIALSTRIMG uideFeb-2017 PRAS tress Test Model Management PrinciplesRecommendationWon Model Risk Management in banksCRD IV / CRRG uidelines on SREPD efines Model Risk (Art.)
6 And the process by which the Competent Authorities should assess how the institutions manage and implement policies and processes to evaluate the exposure to Model Risk as part of the Operational Risk (Art. 85).The Guidelinesoncommonproceduresandmethodolo giesforthesupervisoryreviewandevaluation process definethemainactivitiesthattheCompetentA uthoritiesshouldassessintheinstitution sexposuretomodelriskarisingfromtheuseofi nternalmodelsin itsmainbusinessareasandoperations. Inparticular,theCompetentAuthoritiesshou ldconsiderto whatextent,andforwhichpurposes,theinstit utionusesmodelsto makedecisionsanditslevelofawareness(Mana gementBodyandSeniorManagement)ofandhowit managesmodelrisk.
7 2017 Deloitte Conseil6 Regulatoryreferencesin the EUAccording to SREP Guidelines, the Model risk can be split into two distinct forms of risk with two different impacts risk of risksRisk profile1"Risk relating to the underestimation of own funds requirements by regulatory approved models ( internal ratings-based (IRB) models for credit risk) Competent authorities should consider the Model risk as part of the assessment of specific risks to capital( IRB Model deficiency is considered as part of the credit risk assessment) and for the capital adequacy assessment 2 Risk of losses relating to the development, implementation or improper use of any other modelsby the institution for decision-making ( product pricing, evaluation of financial instruments, monitoring of risk limits, etc.)
8 Competent authorities should consider the risk as part of the assessment of operational risk and it should be evaluated within this perimeterCONTEXTMRM CONTENTSDELOITTE MRM OFFERCONTACTSAPPENDIXCREDENTIALS 2017 Deloitte Conseil7 Regulatoryreferencesin the USThe Federal Reserve and the Office of the Comptroller of the Currency (OCC) collaborated in publishing the Supervisory Guidance on Model Risk Management (OCC 2011-12/SR11-7), which has emerged as the key regulatory guidance for Model risk Management and validation in the US andlays out the basic principles for Model risk Management :Governance, Policiesand ControlsDevelopment, Implementationand UseModel Validation Process Policy Model Definition Inventory Controls Roles& Responsibilities Documentation Model RiskRating Model RiskAggregation Change Control Process Effective Challenge Use of Vendors StakeholderCredentials Life-Cycle Processes RegulatoryInterpretation Design Process Data Assessment Model Testing Documentation Model Limits Model RiskRating Use vs.
9 Intention Processfor Programming Incorporatingin Network DesigningControls TestingImplementation Documentation Model ErrorProcess Validation Procedures Documentation FindingsResolution Nature of Monitoring Extentof Monitoring Frequencyof Monitoring Recalculationprocedures Conceptualsoundness Outcomesanalysis Sensitivityanalysis Documentation Model ErrorProcessCONTEXTMRM CONTENTSDELOITTE MRM OFFERCONTACTSAPPENDIXCREDENTIALS 2017 Deloitte Conseil8 Impact of the New Regulationsand StandardsMore AuditabilityGovernanceand ControlsMore ModelsMore InterpretationsMore InternalCooperationMore ComplexCalculationsMore Financial ImpactMore ImpairmentsMore OftenMore Data Impact FRTBThe FRTB includes updates to both the advanced and standardized models as well as stricter disclosure requirements and validation standards.
10 Impact IRBEBA Guidelines on PD, LGD estimation and treatment of defaulted asset as well as new default definition, conservatism margins, NPL assessment, rating process. Impact of Stress TestingNew stress testing methodology and principles defined by the PRA and EBA. Impact of IFRS9 The introduction of the IFRS 9 Impairments standard is demanding that banks use a new set of credit risk models; these models must be developed, deployed and maintained, which will literally double the number of Risk parameters models to CONTENTSDELOITTE MRM OFFERCONTACTSAPPENDIXCREDENTIALS ECBTRIMG uideTheMRMframeworkshouldinclude:(a)Amod elinventorythat allowsa holisticunderstandingoftheirapplicationa ndusage;(b)Guidelinesonidentifyingandmit igatingtheareaswheremeasurementuncertain tyandmodeldeficienciesareknown;(c)Defini tionsofroles andresponsibilities;(d)Definitionofpolic ies,measurementproceduresand reporting.
