Model Risk Management and the Impacts of COVID-19

Brought to you by RMA’s Model Validation Consortium, our recent Risk Readiness Briefing outlined the challenges facing financial institutions in managing model risk during the COVID-19 crisis. David Andrukonis, Managing Director, RiskSpan and Kevin Oden, Managing Director, RMA Model Validation Consortium (MVC), identified the risks and shared insights and best practices for managing them.

While the 2008 financial crisis resulted in many regulatory changes for financial institutions, it also brought the development of model risk management as a recognized discipline. The COVID-19 crisis is the first major test of model risk management frameworks set up by financial institutions.

The presenters discussed key components of models including input data, processing components, outputs and the overall governance framework, and how these four broad model categories are impacted by the pandemic.

Data drives every model. Without the historical data of a pandemic to rely on, model assumptions and limitations will be tested, introducing data risk. Processing components should be watched for possible weaknesses and failures and to ensure conceptual soundness. It is important to conduct performance monitoring, review senior management and Board reporting for integrity, and modify escalation protocols as appropriate. Good governance relies on openness, transparency, and integrity, performance orientation, and effective collaboration.

The speakers also discussed two environmental factors that call for a potential change to CECL models: the current state of the economy and the forbearance policy of banks. Economic forecasting models should be adjusted to reflect COVID-19-related factors. For credit and prepay models, consider adjusting historical data and input logic, tracking adjusted input performance, while maintaining the ability to compare adjusted and unadjusted models. .

A recording of the webinar is available for download here.

For more information about RMA’s Model Validation Consortium, please send an email to rmaMVC@rmahq.org or visit our website: www.rmahq.org/MVC.


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