Fed / OCC Model Risk Management for Banks

Print Version

Banks routinely use models for many decisions such as valuing exposures, instruments and positions; measuring risk; determining capital adequacy and managing client assets. The expanding use of models reflects their ability to improve business decisions but, as noted in recent guidance from the Board of Governors of the Federal Reserve System, such models also come with costs.

The new guidance (www.occ.gov/news-issuances/bulletins/2011/bulletin-2011-12a.pdf) builds on earlier OCC reports on model validation but now incorporates "the accumulated lessons of supervisory experience and industry practice over the past decade. The broader scope of model risk management now encompasses model development, implementation and use, as well as governance and controls."

Banks are now instructed to make sure their model risk management policies, procedures, and practices are consistent with the guidance. In effect, practices that were previously ‘industry-leading’ are now minimum regulatory expectations. The new requirements include:

Fed/OCC Guidance ClusterSeven Description

Responsibilities must now extend to the whole enterprise, all the way to the Board of Directors

Automated generation of focused stakeholder reports and dashboards on the status of all model activity and associated control processes

Model risk management to be an on-going process, not a periodic activity

Central monitoring ensures continuous, automated checks and validation on all critical items

Rigorous assessment of data quality and relevance

Automated ‘spider-maps’ ensure repeatable, consistent assessment of data quality and provenance

Appropriate documentation

Full automated documentation of model inventories, model usage and volatility, data architecture and verification of control processes

Track and analyze adjustments to data and information

All data amendments, such as for expert judgement are automatically recorded with data trends available ‘on-demand’

Define and maintain standards for model development to which all stakeholders will be held

Flexible central rules enable businesses to define and maintain their own standards. Central monitoring, with automatic notification of breaches, ensures user adherence independent of business pressures

Print Version

“The bar has been raised significantly with respect to the scope, formality, rigor, and prominence expected of banks’ model risk management programs. Program features that were previously considered "industry leading practices" are now minimum regulatory expectations.”

New supervisory guidance on model risk management: Overview, analysis, and next steps,
April 21, 2011

“....all banks should confirm that their practices conform to the principles in this guidance for model development, implementation, and use, as well as model validation. Banks should also ensure that they maintain strong governance and controls to help manage model risk, including internal policies and procedures that appropriately reflect the risk management principles described in this guidance.”

Supervisory Guidance on Model Risk Management
Board of Governors of the Federal Reserve System,
Office of the Comptroller of the Currency
OCC 2011-12