Effective challenge – Beyond the validation

Effective challenge – Beyond the validation

Ahead of the 6th Annual Risk Americas 2017 Convention Michael R. Guglielmo, Managing Director, Darling Consulting Group Inc.spoke to the Center for Financial Professionals, providing insights in to how organisations can execute an effective challenge framework, the role of the audit or stress testing professionals changing as new Dodd-Frank Act reforms become clear from President Trump and more.

  1. Michael, can you please provide our audiences some insights into your experience in the industry and Darling Consulting Group’s focus?

I have been on the banking and consulting sides of the business for over 30 years.  I began my banking career performing econometric forecasting along with capital planning and forecasting through the economic crisis in the late eighties and early nineties. Additionally, I managed the ALCO-related interest rate risk, liquidity risk, and strategic modeling for a regional bank until I joined Darling Consulting Group (DCG) in 1993. During my tenure with DCG, I have been actively involved in developing and managing several of DCG’s consulting and technology-related solutions that more than 1,500 institutions have benefited from over the past three decades.  Additionally, I serve as an educational resource on technical and strategic financial and operational risk management for several industry groups along with examiner training programs.

Darling Consulting Group is a 100+ person independent consulting firm specializing in comprehensive balance sheet risk management services. DCG provides a wide array of risk management solutions including professional model documentation, expert model validation services for all financial and operational risk models including complex DFAST/CCAR credit stress-testing models, balance sheet advisory services, outsourced ALM modeling, liquidity and capital stress testing and deposit and prepayment studies/business intelligence analytics.

  1. How would you recommend organizations execute an effective challenge framework?

Executing an effective challenge framework begins with establishing clearly defined roles and responsibilities for all of the stakeholders involved in the process: 1st line of defense (model owners), 2nd line (model risk management) and 3rd line (audit and the Board). Second, it requires training and ongoing education – often effective challenge is thought to be just a 2nd line of defense function, but all three lines play a collaborative role, and it can’t be fully outsourced. Additionally, senior management and the Board in many instances do not possess the requisite knowledge or understanding to effectively challenge models and modeling processes – having some level of understanding and knowing what questions to ask is crucial for success. One of the best ways we’ve seen a bank address this challenge is to establish a two-way collaborative between the quantitative experts and the internal business executives whereby the quants provided basic education on statistical modeling and telling executives what to look for and the executives in turn provided business expertise. Alternatively, DCG has assisted with the basic statistical education when internal quantitative resources weren’t available.

  1. Can you briefly tell us the effective challenge process, and please advise the most common impediments and pitfalls to avoid?

 Effective challenge is critical analysis performed by informed parties that can identify model limitations and drive appropriate changes. Each line of defense has a role in the process: model owners through their sound development and testing practices and ongoing performance monitoring, MRM through independent technical validations and follow-up questioning, and audit/Board through their review and oversight of related processes and controls and risk appetite.  Common impediments include lack of education and training, lack of sufficient structure, lack of authority and stature for the MRM function, and lack of commitment from higher levels of management.

  1. Do you see the role of the audit or stress testing professionals changing as new Dodd-Frank Act reforms become clear from President Trump?

Given heightened concerns over bank financial and operational performance and stability during this changing economic tide, I do not anticipate too much changing near term with regard to the roles audit and stress testing professionals play. Understanding an institution’s vulnerabilities and the potential impact they may have on capital should not be just a regulatory thing – its prudent business management. In the event that Dodd-Frank Act reforms materialize, forward-looking capital risk assessments for institutions of all sizes will still be practiced, use of models will not diminish, and the need to apply sound model development, management and validation practices will not end. In addition, with operational risks on the forefront of regulatory minds, auditors will continue to have their hands full in the foreseeable future. Longer term, as stress testing matures, we could see some of the specialized resources reallocated to other performance and business intelligence initiatives.   

  1. How do you foresee the industry evolving in the next 12 months, especially since political and economic trends are constantly changing?

Over the next 12 months, there will be a continued focus on credit quality and loan growth without commensurate growth in deposits which will drive increased industry and examiner focus on liquidity and funds management. In addition, emphasis on operational risks including cyber security, fraud, data management, vendor and third-party risk will continue to grow.