In our previous article, we shared a concise overview of some of the key regulatory expectations outlined by the Bank of England’s Prudential Regulatory Authority in its associated Supervisory Statement (SS1/23) for UK banks.
In this post we zoom in on one of the main principles mentioned in SS1/23, Model Risk Classification, which is mainly addressed in Principle 1.3 Model Tiering of the recently published paper. We then show how compliance with the regulatory guidance has been enforced in the default configuration of the Yields MRM platform (see summary table below).
Regulatory Guidance vs. Yields MRM Platform Summary
|1.3 (a)||Firm-wide consistent tiering approach for all models||Section 1|
|1.3 (b)||Model materiality assessment||Section 2|
|1.3 (c)||Model complexity assessment|
|1.3 (d)||Periodic review of the tiering approach||Section 3|
|1.3 (e)||Periodic review of the materiality and complexity assessments||Section 4|
Model risk classification is a foundational aspect of effective model risk management. Model risk classification involves assigning a level of risk to models. This is often referred to as the model’s “tier”. Classifying models based on their tier helps firms to identify areas of focus and to prioritize risk management activities and resource allocation.
At Yields.io we believe that model tiering is better conducted via the execution of a workflow to support full auditability of the events and to guide stakeholders in following the required sequence of actions, e.g. model owners verifying model info accuracy and providing self-assessment of all risk drivers before requesting a review.
Model tiering is typically determined in four moments during the life of a model:
- At inception, when the model is added to the inventory before it goes to model validation and then production. This may be important to decide the level of details of the model validation itself;
- As part of (periodic) model validation, where both model owners and validators review the latest model tier;
- As part of a regular (e.g. annual) model attestation, where the model risk management team requests model owners to certify model tiers, e.g. a change in exposure leads to a new materiality level that may in turn trigger a tier change;
- An ad-hoc model tier update, due to a significant change in the model that cannot wait until one of the above events takes place (see Extract 1).
Extract 1: Ad hoc model tiering workflow in Chiron Enterprise.
We now look at the regulatory guidelines on model tiering one by one, with our complementary observations when required, and briefly describe how the Yields MRM platform addresses the requirements.
1. Firm-wide consistent tiering approach for all models – to ensure all models have an associated risk level and prioritization is made possible.
Yields MRM Platform Solution:
Model owners perform a self-assessment for each risk driver, determining the tier via the use of questionnaires (first action in the workflow of Extract 1). In Chiron Enterprise, questionnaires:
- are configurable from the UI,
- allow the flexibility to be specified as:
- one for all models, to ensure full consistency across the inventory, or
- one per model type, to be able to capture elements that are idiosyncratic to a given family of models, e.g. a questionnaire for ML models may include an explicit assessment of explainability in the complexity dimension.
- can embed logic to automatically determine the tier based on the level of the risk drivers. This can be as simple as defining a tier value for each combination (materiality, complexity) or even based on a computed weighted average score.
Extract 2: Example of a basic questionnaire
HIGH complexity and HIGH materiality automatically lead to “Tier 1”.
2. Model materiality and complexity assessments
Model materiality should include both quantitative and qualitative measures.
Quantitative measures may include:
- book/market value,
- the number of affected users the model relates to.
Qualitative measures reflect model reliance, e.g. usage of the model for (non-)critical business decisions.
Model complexity may take into account:
- the inherent risk of the model, e.g. assumptions, limitations and interdependencies,
- explainability and bias.
Yields MRM Solution:
When it comes to assessing quantitative aspects of model materiality, an example is to run simple scripts in Chiron App to aggregate model exposure and compare it against defined thresholds to determine the level of materiality (e.g. HIGH if aggregate model exposure is higher than £10M). As for qualitative measures, the user may be asked to provide supporting evidence, e.g. by attaching a file.
Extract 3: Providing supporting evidence in tier determination
For model complexity, as inherent risk factors can be captured directly in the model inventory, model owners can easily access this information as part of their self-assessment.
Extract 4: Capturing model limitations in the Chiron Enterprise platform.
For explainability and bias, a mix of quantitative and qualitative analysis can be conducted. For the former, scripts can be run in the Chiron App platform to run tests such as ‘Shapley Values’ and ‘Feature Importance’ for explainability, and ‘Statistical Parity’ and ‘Equal Opportunity Difference’ for bias analysis. Supporting evidence of qualitative elements can also be attached, as in the case of materiality.
3. Periodic review of the tiering approach – to ensure that the approach continues to be valid for a given organization’s reality and that the model inventory information in relation to the model’s tier is kept up to date.
Yields MRM Solution:
Given its full configurability from the UI, questionnaires and model tiering workflows can be modified at any time to reflect any (structural) changes in the process. For example, if the number of models in the inventory is increased substantially, an additional independent risk driver such as Model Reliance may need to be added to achieve higher granularity.
Extract 5: Updating a tiering questionnaire structure in Chiron Enterprise
In order to ensure the model tier is up to date across all models in the inventory, the Campaigns functionality can be leveraged in Chiron Enterprise. This facilitates a centralized execution of model tiering across multiple models in parallel (e.g. as part of the model attestation initiative mentioned above).
A campaign is a collection of workflows (e.g. Model Tiering) that can be run and monitored centrally in parallel for a timely end-to-end execution. As one can imagine, validation and monitoring activities could also leverage a campaign’s functionality.
In Extract 6 below we can see how the model tiering process status is followed for all models (e.g. 2 in the UK legal entity) in the scope of the campaign.
Extract 6: Example of a model tiering campaign in Chiron Enterprise
4. Independent re-assessment of the model tiering determination components as part of the (periodic) validation activities.
Yields MRM Solution:
In Chiron Enterprise, as part of model validation, validators can review the latest model tier self-assessment and can be empowered to decide on the correct final model tier, potentially after overrides, as in the example below.
Extract 7: The model tier is reviewed and finalized by model validation
Model validators can also independently re-run scripts in Chiron App to check the quantitative measures involved in tier determination (as discussed in Section 2 above).
As models continue to play a central role in financial services firms, model risk tiering has become critical to the effective management of model risk. The process of determining model risk tiers is often overlooked, especially when it comes to applying more systematic approaches and providing supporting evidence to conclusions.
As the regulatory expectations and implementation deadline approaches, the Yields MRM platform can assist firms to ensure firm-wide compliance by enforcing a unified tiering approach. The platform allows periodic review of the tiering approach through questionnaires and workflows, as well as the use of campaigns for a centralized execution.
To learn how the Yields MRM Platform can help your firm implement SS1/23, book a personalized demo with one of our MRM domain experts.