UK Prudential Regulation Authority Finalizes Model Risk Management Principles for Stress Testing

The U.K. Prudential Regulation Authority has published a Policy Statement and a finalized Supervisory Statement following a consultation which ran from December 2017 to March 2018 on model risk management principles for stress testing. In the consultation, the PRA proposed that firms that use stress testing models, and that participate in the Bank of England's annual concurrent stress test, should follow in full a set of four proposed principles when establishing and adopting risk management practices in relation to their models. Firms not participating in the BoE's annual stress test should instead seek to apply the four principles on a proportionate basis, taking into account their size, complexity, risk profile and the relevance to the firm of using stress test models.

The Policy Statement sets out feedback on the three responses it received to the consultation. The PRA has made a number of changes to the consultation draft of the Supervisory Statement to address issues raised by respondents. In particular, the PRA has made changes to the wording of Principles 1.2 (Model Inventory), 2.1 (Board oversight), 2.3 (Model developers, owners, users and control functions), 3.1 (Model purpose and design), 3.7 (Business Involvement), 3.8 (Model uncertainty), 3.9 (Model Monitoring), 4.1 (Scope and validation of review) and 4.2 (Independence). In addition, it has included a further section in the Supervisory Statement to set out its expectations on the application of materiality considerations.

The expectations in the finalized Supervisory Statement take effect on June 1, 2018. All firms applying the principles should undertake a self-assessment of their stress test model risk management practices against the principles. This should be done as part of the Internal Capital Adequacy Assessment Process. Firms' findings should be reported in the ICAAP documents from January 1, 2019 onwards, depending on the frequency of the Supervisory Review and Evaluation Process.

View the Policy Statement (PS7/18).

View the finalized Supervisory Statement (SS3/18).

View details of the Consultation.