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Model Risk Management | September 27-28, 2018 | Boston MODEL RISK MANAGEMENT | SEPTEMBER 27-28, 2018 | BOSTON © 2018 Darling Consulting Group, Inc. • 260 Merrimac Street • Newburyport, MA 01950 • Tel: 978.463.0400 • DarlingConsulting.com Page 1 The Faculty Drew H. Boecher Sam Chen Jon Hill Brandon Blanchard Managing Director Quantitative Consultant former Global Head of Model Risk GovernanceVP, Operational Risk Management Darling Consulting Group, Inc. Darling Consulting Group, Inc. Credit Suisse Commerce Bank Joe Montalbano Michael R. Guglielmo Ray Brastow Liming Brotcke Quantitative Consultant Managing Director Senior Financial Economist Quantitative Manager Darling Consulting Group, Inc. Darling Consulting Group, Inc. Federal Reserve Bank of Richmond Federal Reserve Bank of Chicago © 2018 Darling Consulting Group, Inc. Page 2 Agenda – Day One Time Topic 9:00 Next Level MRM [Drew Boecher] 9:45 Regulatory MRM Perspective [Panel: Mike Guglielmo, Ray Brastow, Liming Brotcke] 10:30 Break 10:45 Establishing a Model Risk Management Culture [Brandon Blanchard and Mike Guglielmo] 12:00 Lunch 1:00 Lifecycle of a Model [Brandon Blanchard and Mike Guglielmo] 2:00 Break 2:15 Model Inventory Management [Mike Guglielmo & Jonathan Hill] 3:15 Break 3:30 Managing Inventory Risk: “Should a Model ‘Know’ Its Own ID?” [Jonathan Hill] 4:30 Assessing Model Risk In The Aggregate [Ray Brastow & Liming Brotcke] 5:15 Q&A and Open Discussion © 2018 Darling Consulting Group, Inc. Page 3 Agenda – Day Two Time Topic 9:00 New Era of Data Management [Joe Montalbano] 10:00 Break 10:15 Case Study: Validation of Statistical Models [Joe Montalbano] 11:15 Case Study: Validation of Non-Statistical / Non-Complex Models [Sam Chen] 12:00 Lunch 1:00 Case Study: Validation of Compliance / Data-Driven Models [Brandon Blanchard & Mike Guglielmo] 1:30 Case Study: Validation of Vendor / “Black-Box” Models [Sam Chen] 2:00 Break 2:15 Follow-Up to Validations: The Validation Is Complete – Now What? [Sam Chen & Drew Boecher] 3:00 Break 3:15 The Future State of MRM - Adaptable, Efficient And Effective [Mike Guglielmo & Jonathan Hill] 4:00 Q&A and Open Discussion © 2018 Darling Consulting Group, Inc. Page 4 MODEL RISK MANAGEMENT | SEPTEMBER 27-28, 2018 | BOSTON Next Level Model Risk Management CFP Masterclass Day 1 | 9:00 am Drew Boecher, Managing Director, DCG © 2018 Darling Consulting Group, Inc. • 260 Merrimac Street • Newburyport, MA 01950 • Tel: 978.463.0400 • DarlingConsulting.com Page 5 Model Risk Management Guides Hudson River Rafting Company… © 2018 Darling Consulting Group, Inc. Page 6 Next Level MRM A Industry Trends & the Regulatory Pendulum US Banking Industry Themes, Regulatory Pendulum, Model Proliferation B Contemplating the Future of Model Risk Management SWOT, Regulatory Approaches, Possibilities, Challenges, 3 Lines of Defense, Validator Perspective C Workshop Preview & Motivation MRM Culture, Model Lifecycle, Model Inventory, Aggregate Risk, Data, Validations, Future of MRM © 2018 Darling Consulting Group, Inc. Page 7 US Banking Industry Themes Intensely Competitive Industry 2018 2008 1998 1990 u Consolidating Industry Commerical 4,880 7,076 8,774 12,343 Savings 726 1,229 1,690 2,815 Total Banks 5,606 8,305 10,464 15,158 3/31/2018 12/31/2008 12/31/2001 u Concentrated Industry FDIC Insured Banks 5,606 8,305 9,613 Total Assets (Billions) $ 17,531 $ 13,847 $ 7,868 3/31/2018 12/31/2008 12/31/2001 u Cyclical Profitability Average ROA 1.28% -0.94% 1.14% Average ROE 11.44% -9.88% 12.73% NIM 3.32% 3.34% 4.03% Noncurrent/Total Loans 1.15% 2.93% 1.31% Coverage Ratio 110% 75% 127.56% © 2018 Darling Consulting Group, Inc. Page 8 US Banking Industry Themes 2008-2009 Financial Crisis u Model Proliferation… u …After Model Failures Ø Correlations rise in crises u Bailouts Prevent Bank Failures © 2018 Darling Consulting Group, Inc. Page 9 2009-2016 Regulatory Pendulum Good Times Bad Times Free Enterprise Question Capitalism (“new economy”) (“end of capitalism”) Optimism Pessimism Decreased Regulation Increased Regulation “Geniuses” & “Heroes” “Idiots” & “Villains” Example: Example: 1999 boom led to the 2009-2016: increased emphasis on Stress Testing, Great Depression led to Gramm-Leach-Bliley Act MRM, & Capital Planning the Glass-Steagall Act © 2018 Darling Consulting Group, Inc. Page 10 2011 Model Risk Management Guidance Supervisory Guidance on Model Risk Management OCC 2011-12/ Fed SR 2011-7/ FDIC FIL 22-2017 u Governance Ø Rests with the Board and senior management u Guiding Principle of “Effective Challenge” Ø Critical analysis by objective, informed parties u Model Risk Management Policy Ø Formalize model risk management activities with policies u Project Plan Ø Statement of model purpose u Documentation Ø Include technical documentation u Model Inventory Ø Lists models, locations, owner, developer, etc. © 2018 Darling Consulting Group, Inc. Page 11 2017-2018 Regulatory Pendulum Good Times Bad Times Free Enterprise Question Capitalism (“new economy”) (“end of capitalism”) Optimism Pessimism Decreased Regulation Increased Regulation “Geniuses” & “Heroes” “Idiots” & “Villains” Example: Example: 1999 boom led to the 2017-2018: increased Great Depression led to Gramm-Leach-Bliley Act emphasis on Deregulation the Glass-Steagall Act and Free Markets © 2018 Darling Consulting Group, Inc. Page 12 US Banking Industry Themes Even More Model Proliferation… u More Robust Statistical IRR Liquidity Risk Credit Risk ALLL/CECL AML/BSA Stress Testing Models Funds Transfer u Credit Scoring MSRs Loan Pipeline Loan Pricing Deposit Pricing MRM Guidance Pricing Continues as Dodd- Capital Operational Derivative Profitability Loss Migration Hedging Frank rolled back Planning Risks Pricing Budget Financial Securities Compensation Incentives Loan Valuation Modeling Planning Valuation Deposit Economic Cash Flow VaR Prepayments Fraud Sensitivity Capital Behavioral Salaries & Cost Insurance Taxes Fee Income Models Benefits Allocation © 2018 Darling Consulting Group, Inc. Page 13 Next Level MRM A Industry Trends & the Regulatory Pendulum US Banking Industry Themes, Regulatory Pendulum, Model Proliferation B Contemplating the Future of Model Risk Management SWOT, Regulatory Approaches, Possibilities, Challenges, 3 Lines of Defense, Validator Perspective C Workshop Preview & Motivation MRM Culture, Model Lifecycle, Model Inventory, Aggregate Risk, Data, Validations, Future of MRM © 2018 Darling Consulting Group, Inc. Page 14 Model Risk Management in SWOT Helpful Harmful to achieving objectives to achieving objectives Where does MRM fit in SWOT analysis? Internal Origin Internal How do senior executives and CEO view MRM? § Cost center? Origin External § Profit center? © 2018 Darling Consulting Group, Inc. Page 15 Model Risk Management in SWOT EOM – Opportunity Mgmt. ERM – Risk Mgmt. Strategy to implement Risks to mitigate Enterprise Helpful Harmful Risk to achieving objectives to achieving objectives Management is part of a wider value creation and preservation strategy. Internal Origin Internal If using models strategically, then Origin External Model Risk Management Enterprise Strategy Management (“ESM”) is strategic! © 2018 Darling Consulting Group, Inc. Page 16 Two Approaches to Regulation Prescriptive Principles-based “Tell me what to do” “Tell me the goal” For example, 5% Tier 1 For example, 1996 Interest leverage is required to be Rate Risk policy statement well-capitalized (FIL-52-96) © 2018 Darling Consulting Group, Inc. Page 17 MRM Possibilities – Clarity through Contrast At its worst… … © 2018 Darling Consulting Group, Inc. Page 18 Model Risk Management Possibilities At its worst… At its best… • Fail to distinguish model usefulness • Spread model confusion • Miss quantification errors • Permit opaque qualitative judgment • Generate executive uneasiness • Prompt regulatory concerns © 2018 Darling Consulting Group, Inc. Page 19 Model Risk Management Possibilities At its worst… At its best… • Fail to distinguish model usefulness • Identify useful models • Spread model confusion • Promotes confidence in models • Miss quantification errors • Improve quantitative accuracy • Permit opaque qualitative judgment • Provide transparency • Generate executive uneasiness • Support executive decision-making • Prompt regulatory concerns • Instill regulatory confidence © 2018 Darling Consulting Group, Inc. Page 20 MRM - Horizontal Challenges Phase 3: Strategically Useful – December 2020 Future State X u Improve Design Leadership MRM process improving models for financial benefit Future State E Excellent regulatory and validator ratings Deliver Develop u Communication Unusually effective communication Phase 2: Regulatory Compliant - December 2018 Current State C Improve Design Regulator/Validator Satisfactory u Talent Stakeholders see some benefit Implementation Phase Implementation Deliver Develop Phase 1: MRM Setup MRM Prior State B Improve Design Solid Governance Improved validation Prior State A Deliver Develop No Policy, Limited Governance Now December 2020 © 2018 Darling Consulting Group, Inc. Page 21 Model Governance & Three Lines of Defense Governance: Board (Vision & Tone from the Top) Align risk appetite, business strategies, and the budget 1st Line 2nd Line 3rd Line Business Lines Model Risk Management Internal Audit § Manage the business and § Oversee and challenge business § Review the 1st and 2nd lines model development line risk management § Challenge current processes § Involved in day-to-day risk § Provide guidance, direction and independently management a different perspective § ObJective evaluation and § Follow a risk process § Develop
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