RBI draft circular provides regulatory principles for management of models risks in credit

Reserve Bank of India (RBI), in a draft circular titled Regulatory Principles for Management of Model Risks in Credit, stated that Regulated Entities (REs) shall put in place a detailed Board approved policy with regard to model risk management framework for all models deployed, covering the entire model life cycle. The policy shall cover, inter alia, details of governance and oversight aspects commensurate with model materiality; processes around model development or selection; documentation for models deployed; independent vetting/ongoing validation or review processes; change control; and the monitoring and reporting framework including role of internal audit function. The policy shall also cover the approach with regard to adoption and usage of third-party models. The REs shall maintain a Model Inventory of approved models, insourced or outsourced, with critical information on it.

The central bank noted that the deployment of individual credit models adopted under the policy, and any subsequent changes in their inputs or assumptions, shall be with the approval of the Risk Management Committee of the Board (RMCB) or any other Sub-Committee, as designated by the Board. The models used by the REs may either be developed internally or sourced from external third-party suppliers, including under collaborative lending arrangements, or can be a mix of both as per the provisions of the policy.

The objectives of the model, problem statements and solution sought from the model should be clearly defined and shall be essential pillars of model development. The inputs and assumptions considered for the model development shall ensure adequate robustness, with a view to effectively address the intended objectives of the model on a consistent basis. There shall be a detailed documentation for each of the models which should include the details of the sensitivity of the outputs to the assumptions and inputs, to facilitate clear understanding by RE's users, its top management and supervisors.

The model should have the necessary scalability and flexibility to meet the needs of dynamic business conditions. The model shall have the necessary interface with core banking/financial system, liquidity management, asset liability management (ALM) or any other risk management system of the RE. Outcomes of the model shall be consistent, unbiased, explainable and verifiable. The same shall form part of the model validation framework.

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