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Testing and Validating Asset Liability Management Model Beyond Checking the Compliance Box

ARTICLE| Mon Nov 20 2023

Given risks in the current banking environment, regulators are more aggressively supervising the interest rate risk models. There are two approaches to ALM models validations: i) A full replication of the model being used; and ii) A rigorous testing of the assumptions, calculations and methodology of the subject models. Typically, ALM models are considered “black boxes” where the institution inputs the data, parameterizes the assumptions, and the model outputs the results. The outputs from ALM models are then used to drive major business decisions. If a financial institution does not have full confidence in their model and its ability to produce accurate, reasonable and stable results for their organization, this could result in lost earnings opportunities, potential risk exposures and regulatory exceptions. Banking examiners typically focus on the following three interest rate risk areas:

In order to validate, BankingBook Analytics (BBA) offers both options to its clients, i.e., perform full replication of subject models based on given data or perform a rigorous professional examination of calculations to help our clients not only better understand the fundamental aspects of their models but also to provide a complete assurance in the outputs.

In this first of the five part series, we will outline the tests for key modelling assumptions. Modelling assumptions are not constant but need to be reviewed periodically to ascertain their validity. When reviewing the use and reasonableness of assumptions, it is important to benchmark them across an array of similar institutions. Some notable assumptions that need to be tested at regular intervals are:

Stay tuned for our next article in which we will talk about the treatment of deposit accounts in the context of the validation and testing of Asset Liability Management Models.

For more information on this topic, or to learn how the Team BBA can assist your organization,