As stated in a previous blog post, Time to Re-Model? A Look at Enterprise Modeling Platforms and R Usage in Banking, modeling cannot survive as an island within a financial institution. While a plethora of point solutions have been introduced into the market to meet specific analytical needs – from big data processing to visualization – financial institutions need a more strategic approach to modeling; one that is built, developed, and deployed on a unified platform. Furthermore, financial institutions must proactively monitor, assess, and fine tune model risk management processes on a regular basis ensuring proper model management.
Throughout the years, financial institutions have become heavily dependent on various models for risk calculations, performance management, anti-money laundering, fraud detection, credit risk management, etc. Advanced models are very useful when it comes to dealing with large amounts of complex data and decision making; however, when used incorrectly they can lead to drastic implications as well. There have been instances in the past where the lack of controls on use of models has led to financial losses, such as instances of huge losses and fines incurred by banks owing to lack controls on use of VaR and AML models. Nonetheless, there is no way that institutions can do away with the use of these models; however, the risks arising out of models should be effectively controlled.
As we all know, there has been a plethora of regulations lately and model governance certainly hasn’t been spared here. Basel, Dodd-Frank Act, Supervisory guidelines on model risk management by US Fed and OCC and the list goes on! Gone are the days when regulators were only looking for the accuracy of numbers reported by financial institutions. As of late, they are extending their supervision into the model governance process around model development, accuracy of input data and model documentation. Regulators have started viewing model malfunctioning and lapses seriously and imposing hefty fines on institutions.