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Case Study

Independent Model Validation

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THE CLIENT

The client is one of the largest financial institutions in France. It offers its clients a wide range of products and services: savings, investment, treasury, financing, insurance and investment solutions.

THE CHALLENGE

The independent validation function represents the second line of defence of the risk function, and is in charge of ensuring the soundness and the quality of all internal models (Basel, IFRS9, ICAAP…) in compliance with relevant regulatory requirements. To complete its duties, it conducts a number of independent validation through the year according to an annual plan.

In this context, the focus was on the independent validation of various models as the mission consists in performing:

  • Independent validation for new models;
  • Independent review of models Backtesting;
  • Independent review of ECB obligations assessment related to risk management models.

APPROACH AND SOLUTION

Depending on the time allocated to the validation and what is at stake regarding the model, the independent validation can be performed according to 3 different levels:

  • Level 1 consists of the analysis of documents provided by the modelling team (1st line of defence designing the models) including the methodological and operational information of the model.
  • Level 2 consists of the analysis of the code in which the model has been developed in order to check the appropriate implementation of each aspect analyzed.
  • Level 3 consists of assessing other possible methodologies to be used for the model implied to propose, implement and test an alternative model.

In any case, the approach consists in:

  • Analyzing the relevance of the hypothesis used by modelling team according the operational context of the models, the statistical theory, the business expertise and the regulatory requirements.
  • Expressing findings and recommendation to amend the modelling and implementation approach where necessary
  • Making a follow-up of previous recommendations / obligations expressed by Independent validation team, Internal audit team or ECB during previous reviews

RESULTS AND BENEFITS

By its action, the independent validation team ensures:

  • Identification of the weaknesses of current risk management models.
  • Follow-up of action plans to solve identified weaknesses.
  • Compliance with regulatory requirements.