How a dedicated model validation provider can benefit your bank 

The use of models in the banking industry has been steadily increasing, driven by advancements in technology, the growing complexity of regulatory requirements and the need to optimize limited resources. With better technology, financial institutions now have access to more sophisticated tools that enable more accurate analysis and informed decision-making for management. These models assist in areas such as risk assessment, customer behavior prediction and regulatory compliance. However, as the reliance on these models grows, so does the potential risk. The accuracy of model outputs and reports becomes critically important, as any misuse or errors can lead to significant financial and reputational damage. Balancing the benefits of enhanced technological capabilities with the risks of incorrect or misapplied models is a challenge the industry must continually navigate. 

Model validations have become a large focus to ensure the integrity and reliability of these increasingly complex models. Given that decisions based on model outputs directly impact strategic planning, risk management and compliance, it is essential to validate models as they are deployed and maintained. Validations help identify potential flaws or errors in the model’s design, inputs and outputs and mitigate the risk of inaccurate outputs. They also ensure that the model aligns with regulatory requirements and industry best practices. In a rapidly evolving financial landscape, where market conditions, customer behaviors and regulations frequently change, a consistent model validation framework across all models becomes even more crucial.  

Having a single third party manage all model validations for a financial institution offers a significant advantage by providing a comprehensive and unified perspective on the bank's operations, while simplifying the vendor management process for leadership. When a single validator is responsible for all models, it allows for a more holistic view of the bank's risk profile rather than evaluating each model on its own. This integrated approach ensures that potential interdependencies across different models are identified and addressed, which could be overlooked if different parties validated each model separately. This broader understanding allows the validator to offer strategic recommendations that benefit the bank as a whole. Finally, a dedicated model validation third party helps maintain consistency in the evaluation process, validation outputs and expectations and ensures that the institution's overall risk management framework is robust and aligned with best practices. 

What is a model validation? 

A model validation is the set of processes and activities intended to verify that models are performing as expected and in line with their design objectives and business uses. An effective model validation challenges the model’s data, design, assumptions and estimates, assesses if proper governance has been established and back-tests the assumptions to actual performance. All model components from the front-end model governance to the back-end reporting analytics and everything in between (data inputs, assumptions) should be part of the validation process. The Federal Reserve’s SR 11-7 Guidance on Model Risk Management describes the key elements of a comprehensive validation as: 

• Evaluation of conceptual soundness: assesses the quality of the model design and construction, as well as the documentation supporting the methods used and variables selected. 
• Ongoing monitoring: involves confirming that the model is appropriately implemented and is being used and performing as intended. 
• Outcomes analysis: involves comparing model outs to corresponding actual outcomes.  

Baker Tilly model validation specialists have completed several hundred model validations across all major banking models and our approach adheres to all applicable model validation frameworks described above. Aside from checking the regulatory box, our model validations provide insights into the model, processes, model governance and internal controls to help our clients identify data issues or gaps and enhance transparency of the model functionality.  

A few of the major models that Baker Tilly model validation specialist have experience on include: 

• Current Expected Credit Loss (“CECL”) models, both vendor-based and internally developed 
• Asset/Liability Management (“ALM”) models 
• Mortgage Servicing Rights (“MSR”) valuation models 
• Core deposit study valuations  

By completing multiple validations for one institution, our team can fully understand the interrelationship between models and overall risk. Additionally, model inputs and outputs often feed other models and are used across teams within an institution. Therefore, by selecting one vendor to complete multiple validations not only increases model familiarity across the organization but also allows for enhancements to global model controls and efficiency in all processes. 

Successful operation of your financial institution requires access to reliable data from which you can make informed decisions and manage risk. The ability to explore data and model multiple scenarios in advance of making such decisions provides considerable value to the management of your institution both internally and with regulators. Baker Tilly’s modeling and risk specialists have years of experience providing model analysis and validation services to financial institutions, whether they use purchased or custom-built models. Let us help ensure your institution is making real-time business decisions based on accurate and efficient models.