Model risk arises when models are built on flawed assumptions, trained on biased data, improperly implemented, or applied outside their valid scope. Financial institutions face model risk in credit scoring, trading algorithms, and capital calculations, with errors potentially causing large losses or regulatory penalties. The 2012 JPMorgan London Whale trading loss was partly attributed to spreadsheet errors in risk models. Model risk management includes development standards, independent validation, performance monitoring, limitation documentation, and governance processes to ensure models remain fit for purpose as conditions change.