We have seen a direct correlation between model documentation quality and strength of the model risk management processes.
Model managers who have invested the time in documenting procedures for model updating, and for validation techniques employed to review data, assumptions, and results tend to have stronger, more reliable processes that are repeatable and instill confidence with strategic decision-makers.
Model risk management: second line of defense The model risk management function (the group, individual, or outside resource) represents the second line of defense for model risk management.
This component of MRM is where the “effective challenge” occurs.
This three-tiered approach distributes roles and responsibilities between the model developer/owner/user: the model risk management group/specialist/organizer: and Audit.
This framework provides the structure and accountability that is needed to address the challenges associated with increased dependence on models to make informed decisions and meet heightened regulatory expectations.
For many organizations, assumptions may be adjusted and other changes made, often without the review and approval of a supervisor or governing body (i.e. For example, the key assumptions for an institution’s asset/liability management model should be reviewed and approved by ALCO regularly and conceptually approved by the board, at least annually.
Documentation of any notable changes to a model—in effect, a change log—is now expected.
Requests for our deposit and loan prepayment studies have never been greater as institutions recognize the shortcomings of their existing assumption development and support processes.
In addition, a hierarchical review and approval process related to notable changes made to a model (data, modeling methods, key assumptions, reporting) needs to be instituted. Moreover, assumption development should involve appropriate resources and internal experts, such as business line managers, and needs to be reviewed and approved by management and, in many cases, the board of directors.
• Applying a risk-based approach to the validation process that will inform the validation rigor, frequency of review, and the resources required (internal and external).
For smaller organizations, this process is often being managed by an individual, a small team of two or three, or is still considered part of Audit’s domain.
Effectively managing today’s balance sheet demands evaluating a myriad of alternatives in order to create competitive advantages for your business development teams.