New credit risk standards are game changer for economy

The Reserve Bank of India (RBI) has taken a significant step in enhancing model risk management (MRM) protocols for regulated entities (RES), issuing draft guidelines on 'Regulatory Principles for Management of Model Risks in Credit'.

- DHRUV PARIKH & NIMISH VARMA

The guidelines address the increasing complexity and potential vulnerabilities in credit decision models. The need for a comprehensive framework to manage associated risks is pressing.

Globally, model risk is a recognised concern among financial regulators. The RBI's initiative seeks to resolve several critical issues faced by RES, such as the lack of a formalised mechanism for model-risk management, ineffective policy implementation, unclear model definitions, insufficient model inventory and tiering, and inadequate validation processes.

The guidelines underscore four fundamental elements of MRM: Model definition, governance, development and validation. They provide clear definitions of what constitutes credit-decision models and establish expectations for their application.

REs are required to create an MRM framework, sanctioned by their boards, to oversee model management activities, supported by internal audit reviews.