RBI Proposes New Rules For Algo-Based Lending

The Reserve Bank of India proposed some new rules for managing the risks associated with algo-based lending.

The draft circular, titled 'Regulatory Principles for Management of Model Risks in Credit', laid out the guidelines for all lenders as model outputs are exposed to certain uncertainties and prudence is important.

A credit risk model is one where quantitative methods like statistical, economic, financial or mathematical assumptions are applied to process data for credit decisions, according to the RBI.

Through the draft circular, the regulator has asked all lenders to put in place a detailed board-approved policy for model risk management frameworks for all models being used.

Under this policy, changes in inputs made to individual credit models would require the approval of the risk management committee of the board or any other committee as designated by the board.

The following guidelines have been proposed for such models for all lenders:

• Models used by lenders may either be developed internally or sourced from external third-party suppliers. This includes collaborative lending arrangements or it can also be a mix of both.

• There should be detailed documentation for all models and they must have details on the sensitivity of their outputs.

• The model should also have the necessary scalability and flexibility to meet the needs of changing business conditions. It shall have a necessary interface with the core banking or financial system, liquidity management, asset-liability management or any other risk management of lenders.

• All lenders must also have a model vetting/validation process that is independent of model development/selection. This would help in assessing the robustness of models that are developed in-house and also otherwise.

• The models deployed by all lenders must be subject to supervisory review and the RBI, too, may engage with external experts to validate the models, including the external models.

The draft guidelines would come into effect within three months from the date of its issue and all new credit models that will be adopted by lenders must follow them.