The central bank laid down detailed guidelines on it which will come into force in three months. The lenders already using credit models need to align those with the guidelines within six months from now.
RBI said that while lenders use various models for borrower selection, credit scoring and taking pricing decisions, the outputs are exposed to uncertainties as they are based on assumptions which may not manifest in the envisaged ways and may take different forms in a real-world scenario.
“This potentially exposes the regulated entities to model risk, which has implications on prudential aspects of credit risk management, compliance and reputational risk,” RBI said in the circular.
“While the application of technology in models has facilitated faster decision-making under complex scenarios, it also adds complexity to the model risk management framework implying the need for a comprehensive understanding, a robust validation mechanism as well as appropriate governance and oversight,” it said.
The board approved policy should cover details of governance and oversight, processes around model development or selection; documentation for models deployed. The monitoring of the credit model and reporting framework would include the role of internal audit function, the central bank said.The models adopted by lenders are subjected to independent vetting and ongoing validation or review processes. In case the model is designed externally, the lenders should have “reasonable understanding on design, configuration and operation of the model”, the central bank said.The deployment of individual credit models and any subsequent changes in their inputs or assumptions, shall be with the approval of the risk management committee of the board or any other sub-committee created by the board.
“Regulated entities shall put in place a model vetting / validation process, independent of model development / selection, for assessing the robustness of models developed inhouse or otherwise,” RBI said.
It said that the lenders can consider engaging external experts for validation of the models deployed by them. The central bank may also engage external experts to validate the models deployed by lenders, including the external models deployed for their credit management, based on supervisory risk perception.
