The banking industry has been undergoing radical changes in terms of opting for greater digital presence, managing regulatory and accounting requirements, facilitating managerial decisions and expanding the customer outreach. In this context, to understand the current risk environment in the country KPMG in India conducted a survey titled ‘Model Risk Management Survey 2015-16’. This survey report supports an institution’s efforts to make significant progress toward managing model risk, changes to internal policies and procedures, and substantial investment in processes and systems, while exploring the emerging trends in the banking industry.
The survey respondents were a mix of public sector, private sector and foreign banks based out of India. 35 per cent of the survey respondents were from public sector banks, 53 per cent of the survey respondents were private sector banks and 12 per cent of the survey respondents were foreign banks.
Highlighting the current banking industry scenario in India, the survey report suggests that most banks agree that model risk should be managed by a central unit. Of the respondents, 83 per cent of the public sector banks prefer a fully centralised governance function. In case of private sector banks, 44.5 per cent respondents are in favour of a centralised model. However, a large percentage (33 per cent) would prefer a middle ground by way of a partially centralised model.
The report also analyses the importance of the Board playing an active role in management of model risk. Private sector banks with over 50 per cent of respondents are of opinion in favour of the Board playing an active role, while the remaining wishing to see them play a proactive role in managing model risk. In case of public sector banks, the survey observes that a majority of 50 per cent respondents opine that the Board should play a pro-active role in managing model risk, while approximately 17 per cent feel that the role of the Board should be passive in nature, when managing model risk.
Most of the private sector banks also seem to follow a phased approach to implement model risk management techniques. In case of public sector banks, this systematic approach is less apparent.
“Model risk cannot be eliminated, only mitigated by good management. A combination of expert modelling and robust validation, while necessary, is not sufficient to eliminate model risk,” said Mritunjay Kapur, Partner and Head Risk Consulting, KPMG in India.
The survey also indicates that internal audit department should review all aspects of the model viz. the model risk policy, modelling methodology, model validation, data audit and systems and controls used in model deployment.
In terms of market risk models, just over 50 per cent of private sector banks use proprietary models to compute prices of securities in the trading book; however, this is much higher than the mere 20 per cent of public sector banks that use models for this purpose.
The banking industry in India is a slow-growing one, with majority of the established banks witnessing single-digit organic growth rates over the past years. The survey findings indicate that models are essential to the development of the bank’s retail business. Efficient use of models helps to reduce customer acquisition costs and enhance the profitability associated with each customer.
In a slow growth environment, banks which make efficient use of models/analytics are likely to grow at a higher rate” said Naresh Makhijani, Partner and Head Financial Services, KPMG in India
As the survey outlines, most banks incorporate illiquidity in the price of the security based on the standard haircut based on the type of the security; however, some private sector banks also use proprietary model based haircut, which is a more sophisticated model. The survey also reports that 96 per cent of the private sector respondents perform basic activities with regards to model risk management, however only 44 per cent of them have adopted advanced measures to manage model risk. In case of public sector banks, 39 per cent of the respondents feel that they perform advanced activities with regards to model risk management but only 61 per cent have adopted the basic measures.
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