Managing Risk: Best Practices for Model Risk Management and Model Validation

Where are we today?

The term “model validation” has become a hot topic among regulators and other stakeholders in recent years. DHG, however, believes that the entire model risk management framework, of which model validation is just one component, should be the real focal point. Sound model risk management is not an off-the-shelf product and the size, complexity, product offerings and risk exposures of an organization should be the driving force behind the overall program. It is imperative that the model validation component of the overall risk management program centers on validations that provide an “effective challenge” to a particular model. Finally, it is important to clarify exactly what constitutes a model when developing and/or improving a given model risk management program.

Where to start?

If model risk management and model validation are unfamiliar terms, or if you have been hearing the terms but do not understand what it may mean for you and your organization, we suggest that you start with the regulatory guidance that was published in 2011 by the Federal Reserve (Fed) and the Office of the Comptroller of the Currency (OCC). This guidance was well written and is approximately 20 pages in length. The first three sections, which comprise approximately four-and-a-half pages and include the introduction, purpose and scope, and overview, will provide a base from which to start. You may also search the Internet for either Supervisory Letter SR 11-7 (Fed) or OCC 2011-12 (OCC), and you will find the tools you need to get started.