From credit scoring algorithms to automated investment platforms, financial models underpin almost every major decision in Australia’s finance sector. But what happens when these models go wrong? In 2025, model risk isn’t just a technical concern for banks and insurers—it’s a front-and-centre issue affecting everyday Aussies and the institutions that manage their money.
What Is Model Risk—And Why Does It Matter Now?
Model risk arises when the mathematical or statistical models used in finance produce incorrect results, either due to flawed design, poor data, or unexpected market conditions. In an era where machine learning and AI are driving everything from loan approvals to superannuation projections, the stakes have never been higher.
- In 2025, APRA (Australian Prudential Regulation Authority) has expanded its model risk management (MRM) guidelines to cover not just banks, but also insurers and superannuation funds. This is a direct response to global regulatory trends and several high-profile incidents of model failure in recent years.
- Models are increasingly used for regulatory capital calculations, stress testing, and customer-facing products, increasing their influence—and the potential consequences of error.
- The rise of generative AI and black-box algorithms means that some models are less transparent, making risk harder to quantify.
Recent Examples: When Models Miss the Mark
Model risk isn’t theoretical. In the past two years, Australians have seen real-world consequences:
- Mortgage stress miscalculation: In 2024, a major bank underestimated default risk in certain postcodes due to outdated property data, leading to a spike in arrears and costly write-downs.
- Superannuation projections off-track: Several funds had to issue corrections after their retirement calculators relied on market assumptions that didn’t factor in rapid interest rate rises.
- Insurance pricing errors: An insurer’s AI-driven pricing model set premiums too low for flood-prone areas after failing to account for climate change updates in weather data, leading to a multi-million dollar shortfall.
These incidents have pushed risk management up the agenda for boards and regulators alike.
2025 Policy Updates: What’s New?
This year, APRA has enforced a new cross-industry Prudential Practice Guide on model risk (CPG 250), requiring all regulated entities—not just banks—to:
- Maintain a comprehensive inventory of all models, including AI and machine learning tools
- Implement independent model validation, especially for models affecting capital adequacy, customer outcomes, or regulatory compliance
- Regularly review and stress test models, considering extreme but plausible scenarios (e.g., rapid inflation spikes, cyber incidents)
- Ensure board-level oversight of model risk, with senior executives accountable for governance
For consumers, this means greater protection against systemic errors—but also more scrutiny and possible delays as institutions shore up their processes.
How Australians Can Be Impacted
Model risk can touch every part of your financial life, often in unexpected ways:
- Loan applications: Credit models could misjudge your risk profile, leading to unfair rejections or higher interest rates.
- Superannuation: Retirement calculators might over- or underestimate your future balance, affecting your retirement planning.
- Insurance: Premiums and claims decisions may be skewed if models fail to incorporate the latest climate or demographic data.
As financial models become more complex, transparency and consumer advocacy are increasingly important. The government’s recent push for ‘explainable AI’ in financial services is a direct response to these challenges.
Managing Model Risk: The Road Ahead
For 2025 and beyond, the focus is on robust governance, transparent algorithms, and ongoing model validation. Financial institutions are investing heavily in specialist teams, advanced analytics, and third-party audits. Meanwhile, regulators continue to refine their approach as new risks—like quantum computing and synthetic data—emerge on the horizon.
For the everyday Australian, the key is to remain informed, ask questions about the technology behind your financial products, and watch for updates from your bank, insurer, or super fund.
