Background

• The Office of the Comptroller of the Currency (OCC) charters, regulates, and supervises all national banks. It also supervises the federal branches and agencies of foreign banks.
• In regulating national banks, the OCC has the power to:
• Examine the banks.
• Approve or deny applications for new charters, branches, capital, or other changes in corporate or banking structure.
• Take supervisory actions against banks that do not comply with laws and regulations or that otherwise engage in unsound banking practices. The agency can remove officers and directors, negotiate agreements to change banking practices, and issue cease and desist orders as well as civil money penalties.
• Issue rules and regulations governing bank investments, lending, and other practices.
• OCC has issued certain guidelines for validating  risk models
• These guidelines are largely found in bulletin 2000-16 with some additional points in 2004-59 and 2005-22
• These guidelines cover all aspects of model validations and require independent audit, quality control, thorough documentation and statistical analysis
• Inductis has several solution packages to help financial institutions comply with these guidelines

Importance of Validating Risk Models

• Model Validation not only increases the accuracy of model output, but also familiarizes the user to its strengths and weaknesses  and therefore promotes intelligent implementation.
• Here are some specific reasons for  paying special attention to model validation
• Computer aided models are being increasingly used to make decisions that impact the risk exposure of financial Institutions
• However the modeling process is highly error prone
• Error can creep in at any stage from data collection to the final report generation
• These errors can have significant impact on the risk exposure of the financial institution
• A good validation process can help minimize these errors
• The process should cover all stages of model development
• It should combine statistical procedures with good quality control measures and business judgment
• While these measures are critical for risk models, it is good business practice to apply them to marketing models

Overview of OCC Guidelines

• The OCC guidelines include audit and validation requirements to make risk models more reliable.  The guidelines cover all three components of model development, model information input (assumptions and data), model processing ( theoretical and computer instructions) and reporting ( output and reports).
• Here are some of its salient features
• Understand the meaning and limitations of a model’s results.
• To the extent feasible, model validation must be independent from model construction.
• Modeling process must be well documented
• When a model has been in use for a reasonable period of time, its results should be tested against actual outcomes.
• Information input should be regularly audited in timely and regularly fashion to address input errors.
• The seniority of the management overseeing the modeling process should be commensurate with the materiality of the risk from the line of business in process.
• Responsibilities for the various elements of the model-validation process must be clearly defined.
• Proper model change-control procedures should be in place, to keep record of changes in model codes.

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