PRA outlines principles-based approach to internal models

The PRA today published consultation paper CP6/22, setting out a principles-based model risk management framework for banks and proposing five supervisory principles that cover the full model lifecycle. Key changes include:

• AI and machine learning: CP6/22 explicitly addresses the use of artificial intelligence and machine learning in modelling and states that an overarching model risk management (MRM) framework would support future policy proposals addressing risks from new technologies.

• Five principles: The PRA proposes five MRM principles: Model identification and model risk classification; Governance; Model development, implementation and use; Independent model validation; and Model risk mitigants.

• Proportional application: The consultation proposes that the rigour, intensity, prioritisation and frequency of validation, controls, independent review, performance monitoring and re‑validation should match the model tier assigned to each model.

• Simpler‑regime firms: Where firms operate under simpler regimes, the PRA proposes focusing on meeting the highest‑level outcomes of Principles 3, 4 and 5 and applying individual sub‑principles only where necessary to achieve those outcomes.

• Policy purpose: The stated purpose of the principles is to support firms in developing and implementing policies, procedures and practices to identify, manage and control the risks inherent in the use of models.

• Industry reaction: UK Finance said it supports the PRA's principles‑based, risk‑focused and forward‑looking approach but expressed concern that elements of the draft supervisory statement are expressed in an overly prescriptive way. A short consultation period and the PRA's proposal to apply the framework by model tier aim to give supervisors discretion while setting minimum supervisory expectations for model governance and validation.

--- Sources: https://www.bankofengland.co.uk/prudential-regulation https://www.bankofengland.co.uk/prudential-regulation/publication/2022/june/model-risk-management-principles-for-banks https://www.ukfinance.org.uk/system/files/2022-10/UK%20Finance%20response%20to%20CP6-22%20-%20model%20risk%20management%20principles%20for%20banks.pdf