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2020 and Beyond: What Does the Future Look Like for Model Risk Management?

By Henry Umney, CEO of ClusterSeven.

Model risk management is at the very heart of the financial industry, with models providing the quantitative data required to make informed decisions every single day. In today’s increasingly digital world, institutions are beginning to rely more heavily on models than ever before. The uses of these models are now becoming more varied and complex, and their potential appears never-ending.

The growing complexity of models added to the changes in regulation concerning the use of model risk management has had a transformative effect on the practice. Over the coming months and years, we can expect these changes to develop more fully, as model risk management evolves in line with new digital technologies, changing regulatory requirements, increasing demand and improved awareness. So, what does the future really look like for model risk management?

Growing numbers of models

As the use of models becomes more prevalent, more and more models will be needed to carry out tasks with due diligence. For this reason, we can expect to see financial institutions placed under greater pressure to develop more models – and that means a huge upsurge in model risk.

Whereas before banks might have relied entirely on stress testing results and expert opinions, soon we’ll be seeing far more banks using models to provide quantitative data to back up their decisions. As the numbers of models in use grows, it’ll become more important for professionals to be able to manage a multitude of models in unison. It goes without saying that awareness of risk will be integral to these new responsibilities. It’ll be a case of juggling plates, and never taking an eye off of any of them.

Improvements in awareness of model risk management

Awareness of model risk management is of paramount importance, and in the near future we can expect to see a rapid rise in awareness levels within financial institutions and beyond. Senior management figures are of course expected to comprehend model risk and exposures completely, and these expectations will only rise as awareness improves.

Today, any hiccoughs with regard to management personnels’ understanding could quickly lead to huge rises in risk, with potentially devastating effects. As information regarding models and their usage becomes more readily available, the onus will be on professionals to know models inside and out – and be fully aware of the risks associated with them. Reporting is expected to become more detailed, giving greater attention to context and quantifiable results of models.

Greater reliance on models

Models are now recognised as hugely important providers of data-driven insights, and as we near the end of 2019 we are beginning to see models used far more widely within many different types of organisations.

As the years go on we will undoubtedly see models being used far more in business decisions, and as a result our reliance on models will grow. Of course, it’s worth noting that this increased reliance also leaves businesses open to greater levels of risk, which will bring model risk management to the foreground. As always, professionals will need to focus on the quantitative data their models provide, never losing sight of the value of their models’ results and the context their models operate in.

New technology for model risk management

The usage of models in business is fast becoming mind-bogglingly complex. However, new technology is starting to make life much easier for professionals in this space, providing user-friendly solutions that make managing model risks far easier than ever before.

Technology currently offers the ability to report on risk clearly and succinctly, giving organisations a complete picture of model risk. As this technology develops, we can expect to see more detailed, seamless ways of understanding model risk and eliminating potential pitfalls. Visualisations are already being used to provide unparalleled levels of information on model risk, helping to empower management personnel in decision-making processes.

Our reliance on models is increasing, and with the numbers of models growing rapidly it’s more important than ever that businesses understand associated risks. Big data is already creating more sophisticated models than ever before, and it’s highly likely that the complexity of such models will increase as the years go on. Model risk management is therefore of paramount importance, and will continue to be for as long as risks exist. Look out for new developments in model risk management over the course of 2020 and beyond, as model risk evolves in line with new technology and innovation.

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