Commercial banks have devoted many resources to developing internal models to better quantify their financial risks and assign economic capital. These efforts have been recognised and encouraged by bank regulators. Banks have extended these efforts into the field of credit, market, liquidity and operational risk modelling. However, an important question for both banks and their regulators is evaluating the accuracy of a model’s forecasts of losses, especially given the small number of available forecasts due to typically long planning horizons.
Model development is a complex and error-prone process. While many completed models work as planned, some models contain fundamental errors. Moreover, the internal logic of most models is usually very abstract and limiting, so it requires considerable judgment and expertise to apply model results outside of the narrow context under which they are derived.
This practical course will offer insights into the nature and manifestation of model risk (with a focus on market and credit risk) and identify the implications for misidentifying or neglecting model risk. The exploration of some practical examples will highlight how an apparently well- behaved model can behave very differently under different conditions and the consequences can be catastrophic.
Credit, market and operational model risk will also be examined in the light of the credit crunch and other financial crises. How did these risks influence the severity and duration of the crises? How did a lack of liquidity, strained credit and other issues exacerbate the problem and how can these problems be avoided in future? What are best practices available to validate models?
At the end of the course participants will be able to:
- Acknowledge the importance of model testing
- Identify the main sources of model risk
- Explain the potential consequences of neglecting model risk
- Assess the impact of model risk on various instruments in the banking book
- Be aware of Basel II, III and IV’s consideration of model risk and their relevance to Pillar 2
- Identify processes to limit (if not entirely eliminate) model risk
- Assess the role of senior managers in managing model risk
- Identify procedures for vetting and reviewing models ê Understand best practice for model validation and know some techniques to implement this
- Acknowledge the function of an independent risk oversight (IRO) unit.
Who Should Attend?
- Strategic Business Development professionals
- Risk department staff
- Regulatory department staff
- Internal Auditors