The Federal Reserve Board (FAB) recently released regulatory guidance outlining its capital planning expectations for large financial institutions. The guidance addresses many areas of the capital planning process where regulators are looking for continued improvement within financial institutions and attempts to clarify differences in the Fed’s expectations based on firm size and complexity. The guidance is effective for the 2016 CCAR cycle.
The global financial crisis revealed that many banks had inadequate practices for timely, complete, and accurate aggregation of risk exposures. These limitations impaired their ability to generate reliable information to manage risks, especially during times of economic stress. These limitations resulted in severe consequences to individual banks and the entire financial system.
Responding to this pervasive systemic issue, the Basel Committee on Banking Supervision (BCBS) issued the “Principles for Effective Risk Data Aggregation and Risk Reporting” (RDARR).
Many of the models we validate on behalf of our clients are developed and maintained by third-party vendors. These validations present a number of complexities that are less commonly encountered when validating “home-grown” models.
Notwithstanding these challenges, the OCC’s Supervisory Guidance on Model Risk Management (OCC 2011-12) specifies that, “Vendor products should nevertheless be incorporated into a bank’s broader model risk management framework following the same principles as applied to in-house models, although the process may be somewhat modified.”
If you’ve ever worked with us, you know that we are pretty proud of the fact that we bring the smartest, most dedicated people in the industry to solve our clients’ hardest problems. On our Team page you may read about some of the industry veterans that make up our leadership group. But, we want you to know that our focus on recruiting and deploying the best people extends throughout the organization.
While the execution of robust model risk governance processes are critical for all financial institutions performing annual stress tests, in many cases, the successful delivery of DFAST 2016 results will depend on the institution’s ability to execute as a team and implement disciplined project management approaches.
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Capital is critical to a bank’s ability to absorb losses and maintain adequate liquidity. The financial crisis illustrated that the market’s confidence in the capitalization and overall financial strength of a bank can erode rapidly with changes in economic and financial conditions. This not only imperils the bank’s viability, but the broader financial system as well. For this reason, the Federal Reserve has made assessments of capital planning and analysis of capital adequacy on a post stress basis a cornerstone of its supervision of the largest and most complex financial institutions.
Adequate Capital, But Expect More Capital Planning Scrutiny
The 2015 CCAR results reveal that, while most BHCs have adjusted their portfolios and implemented models that produce quantitative results consistent with regulatory expectations, qualitative processes that support the capital planning process should expect continued regulatory scrutiny over the coming years.
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As model validators, we frequently find ourselves in the middle of debates between spreadsheet owners and enterprise risk managers over the question of whether a particular computing tool rises to the level of a “model.” To the uninitiated, the semantic question, “Is this spreadsheet a model?” may appear to be largely academic and inconsequential. But its ramifications are significant, and getting the answer right is of critical importance to model owners, to enterprise risk managers, and to regulators.
Across the financial services industry, increased oversight has led to significant increases in expenses related to assessing and monitoring risk. We see over and over that institutions are weighted with significantly higher regulatory standards, but are not given commensurate financial resources. Model validation is an area where banks are incurring significant expenses to meet regulatory and internal requirements.
In response to client demand, RiskSpan makes the following recommendations to institutions that are looking to maintain the quality of the model validation process while reducing the associated costs.