RBI releases draft circular on ‘Regulatory Principles for Management of Model Risks in Credit’

Regulated Entities (REs) generally use various models as part of their credit management, including for credit appraisal, borrower scoring, pricing, risk management, etc. With a view to addressing potential risks from use of such models and ensuring robustness in the process of model deployment by REs for credit decisions, the Reserve Bank of India today released the draft circular on ‘Regulatory Principles for Management of Model Risks in Credit’. The Comments on the draft circular are invited from public/stakeholders by September 4, 2024.

The models used by the REs may either be developed internally or sourced from external third-party suppliers, including under collaborative lending arrangements, or can be a mix of both as per the provisions of the policy, subject to the following broad principles:

1. The objectives of the model, problem statements and solution sought from the model should be clearly defined and shall be essential pillars of model development.
2. The inputs and assumptions considered for the model development shall ensure adequate robustness, with a view to effectively address the intended objectives of the model on a consistent basis.
3. There shall be a detailed documentation for each of the models which should include the details of the sensitivity of the outputs to the assumptions and inputs, to facilitate clear understanding by RE’s users, its top management and supervisors.
4. The model should have the necessary scalability and flexibility to meet the needs of dynamic business conditions.
5. The model shall have the necessary interface with core banking/financial system, liquidity management, asset liability management (ALM) or any other risk management system of the RE.
6. Outcomes of the model shall be consistent, unbiased, explainable and verifiable. The same shall form part of the model validation framework.
7. In case subjective factors are used to override model outcomes, then the same shall be as per the provisions of the policy and such deviations shall be suitably documented in an auditable format.