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on model validation: why?

regulatory requirement

 

OCC & OCC 2000-16

• “to help financial institutions mitigate potential risks arising from reliance on computer-based financial models that are improperly validated”
• we have “observed several instances in which decision makers either relied on erroneous price or exposure estimates, or on an overly broad interpretation of model results, with serious consequences for their bank’s reputation and profitability”
• “using unvalidated models to manage risks to the bank is potentially an unsafe and unsound practice”.

Chicago Fed's Risk Committee on current practices

• “traditional relationships between market conditions and balance-sheet behavior have broken down in some cases”
• “advanced interest-rate risk measurement techniques can enhance measurement systems, (but) new techniques may be inappropriately implemented or applied”
• institutions should consider having new models validated to ensure that new techniques have been correctly implemented

sound corporate governance

 

corporate governance issues

• independent review assists in Board & Audit Committee oversight of key risk measurement and management function
• independent opinion on model suitability demonstrates compliance with Board requirement to provide sufficient risk management resources
• regulatory compliance is an element of sound governance
• provides forum for Board & Audit committee education
• increased Board confidence in risk measurement & monitoring processes enhances Board review of risk reporting

Internal Audit partner

• ALM model validation is a niche’ skill set requiring specialized knowledge complemented with years of ALM model experience
  - Internal Audit may not have this niche’ skill set
• Internal Audit provides quality control for ALM model inputs via audit of other bank functions including loan servicing, accounting, and others