Model Risk Paper
Listen to this articleStarting with the Financial Conduct Authority (FCA). The FCA has put forth proposals to strengthen protections for mortgage and credit borrowers.
Strengthening Protections for Mortgage and Credit Borrowers: FCA Proposals
The Financial Conduct Authority (FCA) has proposed stronger protections for mortgage and credit borrowers in a recent consultation issued on May 25, 2023 [1]. The FCA aims to incorporate elements of its Tailored Support Guidance (TSG), which was introduced during the COVID-19 pandemic, into its Consumer Credit (CONC) and Mortgage and Home Finance: Conduct of Business (MCOB) sourcebooks. Additionally, the FCA plans to introduce new rules and provide more detailed guidance to enhance protections for consumers facing financial difficulties.
The key proposals put forth by the FCA include:
- Quarterly statements for mortgage borrowers in payment shortfall: Mortgage lenders will be required to send quarterly statements to borrowers who are behind on their payments, providing them with clear information on their outstanding balance and the actions required to rectify the shortfall.
2. Supplementary guidance for credit providers: The FCA intends to introduce supplementary guidance to CONC to assist credit providers in determining what constitutes “necessary and reasonable costs” when setting fees and charges for customers experiencing payment difficulties.
3. Additional requirements for signposting money guidance and debt advice: The FCA proposes to impose additional obligations on firms to effectively communicate the potential benefits of engaging with guidance and advice providers when signposting money guidance and debt advice.
The consultation period for these proposals will close on July 13, 2023. The FCA plans to publish the final policy in the second half of 2023, with the rules expected to come into force in the first half of 2024. At that point, the FCA intends to withdraw the Tailored Support Guidance.
This consultation follows the FCA’s issuance of final guidance in March 2023, aimed at providing clarity on how mortgage lenders should support borrowers impacted by the rising cost of living [1].
Overall, the FCA’s objective is to establish a stronger framework for firms to support customers facing payment difficulties, ensuring that borrowers receive appropriate support and that their needs are prioritised [2].
PRA Changes: Improving Model Risk Management for Banks
The Prudential Regulation Authority (PRA) has proposed several changes in relation to model risk management principles for banks. Changes to the content of the policy predominantly see the PRA stepping back from the somewhat prescriptive nature of the CP and allowing banks greater scope to interpret some of the requirements with proportionality to their own business complexity and size. This was a common theme in the feedback the PRA received.
Stay with us for a summary of the proposed changes:
Scope of application:
The policy will only initially apply to banks with internal model (IM) approvals for regulatory capital purposes when it comes into force in May 2024. For the rest – guidance is still pending.
Financial reporting:
Replacing a reference to “accounting” so it is available to the audit committee
Senior Management Function accountability:
Remove some of the languages that made SMF for MRM responsible for both first- and second-line activities. SMF can now delegate some activities while retaining accountability for the overall MRM framework;
the SMF holder(s) will have to provide initial and ongoing annual attestations of compliance with the principles.
Model tiering/complexity:
The changes include reducing the prescriptive nature of the wording on model tiering, allowing firms to choose their own relevant factors to determine model complexity. It also clarifies that subsidiaries using models developed by their parent or group can leverage the outcome of the group’s validation process as long as the principles on validation are met.
Vendor models:
Changes have been proposed regarding the use of vendor models. The changes include reducing the prescriptive nature of the wording on model tiering, allowing firms to choose their own relevant factors to determine model complexity. It also clarifies that subsidiaries using models developed by their parent or group can leverage the outcome of the group’s validation process as long as the principles on validation are met.
AI/ML models:
The PRA has introduced modifications specific to AI/ML models – emphasising the importance for AI/ML governance and controls.
Post Model Adjustments (PMA):
Amendments have been made to the framework governing post model adjustments. It introduces changes to acknowledge the need for proportionality in PMAs, taking into account the specific circumstances of each bank. This approach emphasises a more balanced and flexible approach to PMAs.
Delegation of board responsibilities:
The PRA has proposed changes around the delegation of board responsibilities. firms should have strong governance oversight with a board that promotes an MRM culture from the top through setting clear model risk appetite
Use of group models by subsidiaries:
Subsidiaries: there is clarification that subsidiaries using models developed by the parent-group may leverage the outcome of the group’s validation of the model if certain conditions are satisfied.
Linkage between dynamic recalibration and model changes:
The PRA provides additional guidance on the need to evaluate the cumulative impact of dynamic recalibrations over an appropriate duration to determine if any adjustments to the model are necessary.
Escalation process:
The PRA has proposed making the escalation process less prescriptive, taking proportionality into consideration.
Readability and consistent terminology:
Minor changes have been made to improve the readability of the Supervisory Statement and ensure the use of consistent model risk management (MRM) terminology.
It’s important to note that these proposed changes are subject to further review and may be refined before their final implementation. For more detailed information on the proposed changes, please refer to the relevant publications by the Prudential Regulation Authority.
