The European Central Bank (ECB) has been enforcing MRM principles through its Targeted Review of Internal Models (TRIM) project launched in 2016 in close cooperation with the national competent authorities (NCAs) that are part of the European banking supervision. With the issuance of revised guidelines on Internal Model Governance in its release version 3.0, the ECB aims to harmonize topics related to internal models. This encompasses governance, validation, audit, as well as climate-related and environmental risks.
The ECB’s guidelines advocate for a holistic approach to MRM, emphasizing the importance of documentation, implementation of risk management frameworks, and the establishment of a governance structure that includes senior management. The guidelines also cover general principles for internal validation, audit, and the management of climate-related and environmental risks.
Each bank’s unique situation will be considered in the reviews conducted by the ECB, ensuring that the application of the MRM framework is tailored to the unique characteristics of each institution. This approach reinforces the necessity of a consistent and structured methodology towards MRM, necessitating effective implementation and expansion across various teams within banks, including Risk, IT, Model Development, and Third-party Service Providers.
Looking ahead
As the regulatory landscape evolves, the drivers for MRM solutions are becoming increasingly clear. The EU is steering towards more rigorous, comprehensive, and technologically advanced MRM frameworks. This transition signifies a pivotal moment for financial institutions, which must now adapt to these changes with strategic investments in technology and governance structures.
As model risk management becomes increasingly customized, nuanced and rooted in specificities, such as model validation, calibration and so on, banks will need to revolutionize their approach to it through technology enablement. Despite initial challenges, this shift presents an opportunity for banks to enhance their risk management practices, improve operational efficiency, and align more closely with regulatory expectations. As we move forward, the ability of banks to navigate this changing regulatory terrain will be crucial in maintaining financial stability and fostering trust among stakeholders.
Author
Prashanth Belugali N
Principal Product ManagerPrashanth has two decades of experience working with large banks, asset managers, trading & capital markets models and model risk domain. He has worked as a quantitative analyst, delivery manager, and product engineer, and provided bespoke solutions in quants (asset management, trading) and risk management practices (credit risk, market risk, model risk), and data engineering to a global clientele
