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COVID-19 and CECL Requires Model Validation 

The implementation of the CECL standard.  An unprecedented pandemic.  Record volume of PPP loans originated.  Extraordinary levels of individual stimulus payments.  The confluence of these events, most of which were unforeseen under even the wildest of economic scenarios, have highlighted unexpected flaws in models that financial institutions have relied on for years.  Many banks are finding that their models have “broken” and require significant adjustments (or even a complete overhaul) to reflect current realities. 

Auditors are already requesting that banks utilize challenger models and scrutinize their methodologies, and expectations from a regulatory perspective are ever-growing, thereby increasing the burden that falls on traditional Model Risk Management (MRM) groups to validate these models. SR 11-7, which provides regulatory guidance for MRM, states that “rigorous model validation plays a critical role in model risk management.” The importance of this role has increased right alongside model complexity.

Not sure where to start? An independent Model Validation will help your MRM department enhance their risk management process by addressing and even avoiding such model failures, ultimately creating a more resilient model strategy.  Valuant’s team has experience validating the incurred loss model along with CECL models, both built internally and those purchased from 3rd party vendors. Our independent model validation can assess the following: 

Documentation Policies and Procedures

Determine whether policies are clearly defined, documented, and approved so that the Bank can react quickly in a rapidly changing environment. Policies should address:

  • Roles and responsibilities of personnel
  • Model Maintenance and Access Permissions
  • Model Documentation and Review
  • Model Validation Processes and Scope
  • Change Management Procedures 

Conceptual Soundness and Accuracy of Modeling

Assess key components of model risk as outlined by SR 11-7, including but not limited to:

  • Design objectives, intended business use, and alignment with applicable standards
  • Mathematical accuracy of calculations and quantifications
  • The integrity of underlying data
  • Appropriateness of the selection and use of inputs such as economic metrics and forecasts
  • Correct use and application of model outputs

Ongoing Monitoring and Review 

Evaluate the processes currently undertaken to monitor model performance. Ongoing review is essential, even for brand new model(s) including:

  • Periodic review of the relevance and accuracy of key assumptions, inputs, and risk factors
  • Assessment of the model’s impact elsewhere, such as on downstream models
  • Evaluation of back-testing strategies and sensitivity analyses, ensuring that the model is functioning correctly as current conditions change  

In a rapidly evolving economy such as what we are experiencing today, proper model management is essential to sound decisions, and Valuant can help.  Contact Us.

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