Model risk management principles for stress testing

Published 30 April 2018

Model risk management principles for stress testing – PS7/18

Overview

This Prudential Regulation Authority (PRA) Policy Statement (PS) provides feedback to responses to Consultation Paper (CP) 26/17 ‘Model risk management principles for stress testing’. It contains the final Supervisory Statement (SS) 3/18 ‘Model risk management principles for stress testing’.

This PS is relevant to PRA-authorised banks, building societies and PRA-designated investment firms (‘firms’). The PS is not relevant to credit unions and there is currently no proposal to extend the policy to insurance and reinsurance firms. 

Summary of responses

The PRA received three responses to the proposals in CP26/17. Respondents were supportive of the model risk management principles for stress testing, but also asked for further clarification, guidance and alternative wording in some areas. The PRA’s feedback to responses, and decisions, are set out in Chapter 2.

Implementation

The expectations in SS3/18 will take effect from Friday 1 June 2018.

All firms applying the principles are expected to undertake a self-assessment of their stress test model risk management practices against the principles as part of the Internal Capital Adequacy Assessment Process (ICAAP) and report the findings in the ICAAP documents from Tuesday 1 January 2019 onwards, depending on the frequency of the Supervisory Review and Evaluation Process (SREP).

Policy Statement 7/18

Appendix

• Model risk management principles for stress testing - SS3/18

Published 6 December 2017

Model risk management principles for stress testing – CP26/17

Background

This consultation paper (CP) sets out the Prudential Regulation Authority’s (PRA’s) proposals to support effective practices in model risk management for stress testing. A set of principles has been developed in the context of the annual concurrent stress testing process, which tests the resilience of the banking system and some of the largest firms within it. The PRA proposes to embed these principles further for firms participating in the annual concurrent stress tests, while also extending them, in a proportionate manner, to the wider banking sector.

The CP is relevant to PRA-authorised banks, building societies and PRA-designated investment firms (‘firms’). Credit unions are not in scope and there is currently no proposal to extend the principles to insurance and reinsurance firms 

Summary of proposals

The primary objective of stress testing is to help regulators and firms assess capital positions under adverse economic conditions. This exercise allows regulators to help inform the setting of capital requirements for both microprudential and macroprudential purposes. Banks are also increasingly using stress results of stress tests to inform strategic and business decisions.

Taking a proportionate approach, the PRA proposes:

(a) that firms participating in the Bank’s annual concurrent stress test should adopt the principles for all stress test models; and

(b) firms not participating in the Bank’s annual concurrent stress testing should take into account their size, nature, scale, complexity of business activities and use of stress test models when seeking to apply the principles. For these firms the PRA proposes at a minimum:

(i) implementation of Principles 1 and 2 (ie establish a model definition, maintain a model inventory and implement an effective governance framework, policies and procedures); and
(ii) application of Principles 3 and 4 (ie implement a robust model development process and undertake validation and independent review) to models they have identified as material 

Responses and next steps

This consultation closes on Tuesday 6 March 2018. The PRA invites feedback on the proposals set out in this consultation. The PRA is particularly interested in respondent’s’ views on the usefulness and applicability of the proposed principles for firms not participating in the Bank’s annual concurrent stress test. Please address any comments or enquiries to CP26_17@bankofengland.co.uk. 

Consultation Paper 26/17