A decade after regulators began requiring banks to validate the effectiveness of their financial models, a talent shortage is hampering industry efforts to comply.
More than seven in ten respondents to a recent survey said a talent shortage is a challenge to meeting requirements, more than any other response.
Some banks use as many as 800 different models to guide lending decisions and other determinations in their business, according to the survey of 62 banks, which was carried out by the Risk Management Association.
“When you look at the number of banks and the number of models in the industry, you can see why there’s a real lack of talent needed to validate them,” said Ed DeMarco, general counsel at the Risk Management Association.
Banks’ financial models must be tested through a careful process that the Federal Reserve, the Office of the Comptroller of the Currency and later the Federal Deposit Insurance Corp. began to take a closer look in the wake of the 2008 financial crisis.
Regulators found that the models that much of Wall Street relied on collapsed at the height of the crisis, producing loss estimates that were “ridiculously lower” than what had been realized on mortgage-backed securities. risk, researchers wrote in a report by the Risk Management Association.
According to the survey, six out of 10 banks said they now validate their riskiest and most complex models every two years.
But the rise of digital finance companies and the lure of tech giants has turned qualified candidates away from traditional banks, which more often have to outsource work, the survey found.
Specific skills are needed to perform the validations, said Chris Nichols, director of capital markets at SouthState Corporation, with $46.2 billion in assets in Winter Haven, Florida. It is crucial to rely on technicians who are creative enough to solve problems related to frequent data gaps, he said.
Recently, as more skilled talent has gone to big tech companies, the models have also become more complex, often relying on machine learning capabilities, according to Nichols.
“Model validation can be daunting,” he said.
Independent Community Bankers of America is in talks with federal banking agencies to allow smaller banks to collaborate, share resources and personnel, and recognize common standards, according to Michael Emancipator, group vice president and regulatory advisor. that could make the process more efficient. .
According to the ICBA, about eight in ten community banks say they pay outside companies to help them manage digital products. But current guidelines require banks to have internal employees who know how to manage relationships.
“This can create a bit of a bottleneck considering the limited number of experts in these fields, coupled with the Great Resignation that’s unfolding right now,” Emancipator said, referring to the surge of Americans who have quit their jobs in the time of the pandemic.
In the survey, about 72% of respondents cited “talent” as a challenge to model validation, followed by 63% who cited “costs.” Some 37% of respondents mentioned “banking resources” and 9% mentioned “technology”.
Even banks with the resources to tackle the model validation process head-on should take extra care when purchasing or building a new model or additional datasets, Nichols said.
The bank’s management may face a “difficult decision when trying to determine the margin of error tolerance in its validation practice”, he added.
“The big banks need to be more rigorous. So while the talent is more likely to be available, the exercise becomes more costly and relatively time-consuming,” Nichols said.