Regulatory Requirements & Other Guidance
Regulatory Requirements and Other Guidance
Our validation approach will meet model validation regulatory guidance of:
Comprehensive Capital Analysis and Review 2012: Methodology and Results for Stress Scenario Projections March 13, 2012
The Federal Reserve expects large, complex bank holding companies to hold sufficient capital in order to maintain access to funding, to continue to serve as credit intermediaries, to meet their obligations to creditors and counterparties, and to continue operations, even under adverse economic conditions. The Comprehensive Capital Analysis and Review (CCAR) is a supervisory assessment by the Federal Reserve of the capital planning processes and capital adequacy of these large, complex bank holding companies (BHCs). The CCAR is the Federal Reserve’s central mechanism for developing supervisory assessments of capital adequacy at these firms.
Nineteen BHCs were required to participate in this year’s CCAR (CCAR 2012). In early January, these BHCs submitted comprehensive capital plans to the Federal Reserve, describing their strategies for managing their capital over a nine-quarter planning horizon. The purpose of requiring BHCs to develop and maintain these capital plans is to ensure that the institutions have robust, forward-looking capital planning processes that account for their unique risks and that the institutions have sufficient capital to continue operations throughout times of economic and financial market stress. As part of its assessment of the plans, the Federal Reserve projected losses, revenues, expenses, and capital ratios for each of the 19 BHCs under a severely adverse macroeconomic scenario specified by the Federal Reserve. This paper describes this scenario, provides an overview of the analytical framework and empirical methods used by the Federal Reserve to generate these stress scenario projections, and presents the results.
HIGHLIGHTS OF THE LEGISLATION
Consumer Protections with Authority and Independence: Creates a new independent watchdog, housed at the Federal Reserve, with the authority to ensure American consumers get the clear, accurate information they need to shop for mortgages, credit cards, and other financial products, and protect them from hidden fees, abusive terms, and deceptive practices.
Ends Too Big to Fail Bailouts: Ends the possibility that taxpayers will be asked to write a check to bail out financial firms that threaten the economy by: creating a safe way to liquidate failed financial firms; imposing tough new capital and leverage requirements that make it undesirable to get too big; updating the Fed’s authority to allow system-wide support but no longer prop up individual firms; and establishing rigorous standards and supervision to protect the economy and American consumers, investors and businesses.
Advance Warning System: Creates a council to identify and address systemic risks posed by large, complex companies, products, and activities before they threaten the stability of the economy.
Transparency & Accountability for Exotic Instruments: Eliminates loopholes that allow risky and abusive practices to go on unnoticed and unregulated — including loopholes for over-the-counter derivatives, asset-backed securities, hedge funds, mortgage brokers and payday lenders.
Executive Compensation and Corporate Governance: Provides shareholders with a say on pay and corporate affairs with a non-binding vote on executive compensation and golden parachutes.
Protects Investors: Provides tough new rules for transparency and accountability for credit rating agencies to protect investors and businesses.
Enforces Regulations on the Books: Strengthens oversight and empowers regulators to aggressively pursue financial fraud, conflicts of interest and manipulation of the system that benefits special interests at the expense of American families and businesses
The financial regulators are issuing this advisory to remind institutions of supervisory expectations regarding sound practices for managing interest rate risk (IRR). In the current environment of historically low short-term interest rates, it is important for institutions to have robust processes for measuring and, where necessary, mitigating their exposure to potential increases in interest rates. Current financial market and economic conditions present significant risk management challenges to institutions of all sizes. For a number of institutions, increased loan losses and sharp declines in the values of some securities portfolios are placing downward pressure on capital and earnings. In this challenging environment, funding longer-term assets with shorter-term liabilities can generate earnings, but also poses risks to an institution’s capital and earnings.
This bulletin provides guidance to help financial institutions mitigate potential risks arising from reliance on computer-based financial models that are improperly validated or tested. The guidance outlines key model validation principles and the Office of the Comptroller of the Currency’s (OCC) expectations for a sound model validation process. The expectations included in this bulletin supplement previously issued model validation guidance, generally found in the subject matter booklets of the Comptroller’s Handbook or OCC Bulletins.
Computer models are abstract representations of the various relationships among events and values in the real world. They are used in banking to estimate risk exposure, analyze various business strategies, and estimate fair values of financial instruments and acquisitions. Due to a better understanding of their potential enhancement to management information systems, and due to the ongoing reduction in the cost of computing power, models are playing a progressively more important role in the banking industry. The tools are now routinely used for credit scoring, asset-liability management, trading-risk management, and for valuation estimates of financial instruments, such as securitization retained interests. In the next decade, it appears that the models will increasingly guide enterprise wide risk management, economic, and regulatory capital allocation, whole-bank credit risk, fiduciary asset management, and internal profitability measurement. In light of this increasingly pervasive use, it is apparent that models can provide extremely useful information for bankers’ decision making.
FDIC December 7, 2007 Supervisory Insight article on Model Governance
Board of Governors of the Federal Reserve System – Subject: Joint Policy Statement on Interest Rate Risk SR 96-13 (SUP). May 23, 1996
Enclosed is an interagency policy statement approved by the Board of Governors of the Federal Reserve System, the Office of the Comptroller of the Currency and the Federal Deposit Insurance Corporation that provides guidance to examiners and bankers on sound practices for managing interest rate risk. These practices will form the basis of the agencies’ ongoing evaluation of the adequacy of interest rate risk management at their supervised institutions. The policy will become effective upon being published in the Federal Register which is expected in the next few days.
Also, the preamble to this statement formally notifies the industry that the banking agencies have elected not to pursue a standardized supervisory measure of interest rate risk that was issued for public comment in August 1995. In supervising interest rate risk, the agencies intend to emphasize reliance on internal measures of risk, promotion of sound risk management practices, and continued use of surveillance screens to identify those institutions that appear to be taking excessive risk.
Federal Housing Finance Agency Division of Federal Home Loan Bank Regulation – Validation and Documentation of Models and Related Controls on Internal Processes – ADVISORY BULLETIN,2009-AB-03, December 15, 2009
This Advisory Bulletin replaces Advisory Bulletin 2006-AB-02, Validation and Documentation of Models and Related Controls on Internal Processes. The earlier Advisory Bulletin focused on market risk models. This Advisory Bulletin explicitly includes credit risk models and also addresses the validation of externally-managed vendor models, internally-managed vendor models, and the importance of validating and documenting the controls over models and their use. In addition, this Advisory Bulletin discusses model validation and documentation in the case of a model that is jointly used by several FHLBanks. The guidance provided in this Advisory Bulletin is effective immediately.
The Federal Home Loan Banks (FHLBanks) and the Office of Finance (OF) use financial models in a variety of areas including financial instrument valuation, market and credit risk measurement and control, and financial forecasting. While models are essential in managing large, complex institutions, reliance on inaccurate or inappropriate models may lead to poor or costly decisions. To mitigate model risk, each FHLBank and the OF should implement policies and procedures to ensure appropriate documentation and validation of all “mission-critical” and important models. FHLBanks and the OF should apply the same principles outlined in this Advisory Bulletin to internally developed and vendor provided models, whether used and managed in-house by the FHLBank or the OF, or externally by the vendor. Throughout this advisory bulletin “model documentation and validation” should be read to include proper testing of related controls on the processes surrounding those models.
Financial modeling is increasingly important to the banking industry, with almost every institution now using models for some purpose. Although the use of models as a management tool is a significant advance for the industry, the models themselves represent a new source of risk – the potential for model output to incorrectly inform management decisions.
Although modeling necessarily involves the opportunity for error, strong governance procedures can help minimize model risk by
- Providing reasonable assurance the model is operating as intended;
- Contributing to ongoing model improvement to maintain effectiveness; and
- Promoting better management understanding of the limitations and potential weaknesses of a model.
This article briefly discusses the use of models in banking and describes a conceptual framework for model governance. In addition, the article suggests possible areas of examiner review when evaluating the adequacy of an institution’s model oversight, controls and validation practices.