What is Validation?

Many community banks are finding that their regulators now expect more from them in terms of their risk management and validation practices. For banks new to the validation process, a number of questions arise:

  • What exactly is validation?
  • Is it just a regulatory exercise, or can business value be extracted?
  • How much should the bank invest in validation?
  • Given a fixed budget, how can validation be done in the most effective way?

Validation is often thought of as an obscure mathematical exercise, involving statistical concepts such as power curves and accuracy ratios that are not relevant to community banks. But even though quantitative testing is part of a robust validation approach, a complete solution goes far beyond just looking at the numbers. A proper validation answers the following questions:

  • Are the scorecard governance procedures appropriate and effective?
  • Does the universe of scorecards used by the bank reflect how it does business?
  • Are scorecards easy to use?
  • Do scorecards make intuitive sense?
  • How do scorecard users feel about scorecards?
  • Do scorecards perform well in a statistical sense?

Many banks new to the validation process tend to think of it as a low-value-added regulatory hoop to jump through. It’s true that annual validation is an essential part of regulatory compliance. However, we encourage banks to look at validation as an opportunity to gain a competitive edge and to invest in it accordingly.

At its heart, validation is about asking “Do our risk measurements and management processes make sense?” and “Where are our opportunities for improvement?” The banks that are most committed to continual improvement in how they assess their obligors are more likely to enjoy success in the future.

The practice of annually validating scorecards also ensures that they are discussed at least once a year. This provides opportunities for identifying and rectifying any potential misunderstandings or concerns.

Finally, the validation process allows the bank to optimize its investment in scorecard development and redevelopment, by identifying the scorecards and other aspects of the risk measurement process that are working best and those most in need of improvement.

The above is based on an excerpt from The RMA Journal, April 2015 article “Validating Your Competitive Advantage” by Jan Larsen, director of enterprise risk solutions at Moody’s Analytics and Christian Henkel, senior director of enterprise risk solutions at Moody’s Analytics. 

Washington - The Week Ahead, February 4-8, 2019

Read More

NPR Implementing Section 205 of the Economic Growth, Regulatory Relief, and Consumer Protection Act

Read More

Washington – The Week Ahead, July 23-27, 2018

Read More

comments powered by Disqus