Model Validation Practice in Banking: A Structured Approach

Abstract: This paper presents a comprehensive overview of model validation practices and advancement in the banking industry based on the experience of managing Model Risk Management (MRM) since the inception of regulatory guidance SR11-7/OCC11-12 over a decade ago. Model validation in banking is a crucial process designed to ensure that predictive models, which are often used for credit risk, fraud detection, and capital planning, operate reliably and meet regulatory standards. This practice ensures that models are conceptually sound, produce valid outcomes, and are consistently monitored over time. Model validation in banking is a multi-faceted process with three key components: conceptual soundness evaluation, outcome analysis, and on-going monitoring to ensure that the models are not only designed correctly but also perform reliably and consistently in real-world environments. Effective validation helps banks mitigate risks, meet regulatory requirements, and maintain trust in the models that underpin critical business decisions.