TREND No. 5 Risk model validation. Another trend, driven not just by Basel, but by the intensified scrutiny of banks in general in the aftermath of the financial crisis, is the validation of risk models and reporting on the use and effectiveness of models across the organization.
The Office of the Comptroller of the Currency issued a paper in April about best practices for model validation in banking. "Banks rely heavily on quantitative analysis and models in most aspects of financial decision-making," the OCC said in its report. "They routinely use models for a broad range of activities, including underwriting credits; valuing exposures, instruments and positions; measuring risk; managing and safeguarding client assets; determining capital and reserve adequacy; and many other activities. ... The expanding use of models in all aspects of banking reflects the extent to which models can improve business decisions, but models also come with costs. There is the direct cost of devoting resources to develop and implement models properly. There are also the potential indirect costs of relying on models, such as the possible adverse consequences (including financial loss) of decisions based on models that are incorrect or misused. Those consequences should be addressed by active management of model risk."
BANK DOING THIS: First Gulf Bank uses Standard & Poor's risk solutions to validate its probability of default ratings models.
TECH PROVIDERS: IBM SPSS, S&P (risk model validation service) FICO (model central) and Quantifi.
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