What is Model risk?
Regulation
Model risk is the exposure to poor decisions caused by flaws in the design, data or use of a scoring model or credit policy. It is mitigated through governance: independent validation, versioning, performance monitoring and full traceability of every change.
How it is governed
Controlling model risk requires knowing which policy version decided each case, who approved it and on what data. Without traceability there is no way to validate a model or to answer a regulator.
Common questions
Why does it matter to banks?+
Credit risk regulatory frameworks require models to be validated and documented. Policy versioning and decision traceability are the evidence that this governance is actually in place.
Related terms
Decision traceability
Decision traceability is the ability to reconstruct, for any given case, which policy was applied, on what data, which version was live and what outcome it produced. It is the baseline requirement for auditing, explaining and defending a credit decision to customers and regulators.
KYC and AML
KYC (know your customer) is the set of checks confirming a person is who they claim to be. AML (anti-money laundering) covers the controls to detect and report suspicious activity. Both are regulatory obligations prior to granting credit.
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