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KPMG in Sri Lanka hosts Training on Model Validation and Governance

Training on Model Validation and Governance

Global economies are currently undergoing the phase of striving to recover from the financial crisis, whereas regulators and businesses are making efforts to retaliate immediately. The recent economic downturn has brought light to many shortcomings of the existing regulatory framework, governance structures and risk assessment techniques.

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Global economies are currently undergoing the phase of striving to recover from the financial crisis, whereas regulators and businesses are making efforts to retaliate immediately. The recent economic downturn has brought light to many shortcomings of the existing regulatory framework, governance structures and risk assessment techniques.

Regulators have continued to enforce stern laws to be abide by financial institutions to use apposite comprehensive risk management procedures. The ongoing changes will force financial institutions to implement frameworks and governance structure that reflect not only the ability to validate but also the efficacy of controls that govern the design, development and revision of the models.

With this background set, The Academy of KPMG in Sri Lanka organized a session on “Model Validation and Governance Training” to encompass corporate leads with KPMG’s global expertise on validation and governance techniques. The event took place in February at the Galadari Hotel, Colombo with the graceful participation of many Board of Directors, CFOs and Internal Auditors.

The sessions were conducted by Raditha Alahakoon (Partner - Accounting Advisory Services, KPMG in Sri Lanka), Thamali Rodrigo (Partner – Audit, KPMG in Sri Lanka) and Pyumi Sumanasekara (Director – Audit; GAD, KPMG in Sri Lanka).

The session began by Raditha sharing his thoughts on Model Risk Management, a topic that has made its way to the top with the changing regulatory frameworks in today’s context. The session focused mainly on how Model Risk could affect the credit quality of financial institutions.

Model Risk management could be critical given the size and complexity of typical model portfolio, the highly-specialized knowledge encapsulated in them, the sophistication of both the algorithms and the underlying technologies, and the extent and diversity of the environments in which they are used.

Raditha provided valuable insight on the importance of having adequate controls in place for implementation of better models for business use.

Key highlights from Raditha’s presentation were:

  • Model risk arises from decisions made based on incorrect, misused, or misinterpreted model outputs.
  • Three main types of model risks exist; Wrong Model – inapplicability and incorrect specifications of the model, Model Implementation – programing errors, technical and inappropriate assumptions, Model Usage – implementation and calibration errors and use for unintended purpose.
  • The sources of Model Risk could be known as; Uncertainty or Volatility, Inconsistency over time, Correlation uncertainty, and Data and Model complexity.
  • The Central Bank of Sri Lanka has been exerting pressure on the Banking and Finance sector through the latest directives on SLFRS9 Credit Risk Management Model Validation.
  • The Model Risk Management (MRM) approach is comprised of; 01. Core Components that are inclusive of model inventory, model development and model validation. 02. Supporting framework including model risk governance, data Management, and technology support. 03. Internal audit as the third line of defense.

As the conclusive lines of the presentation, Raditha mentioned a critical responsibility of the board of directors in terms of risk, “It is critical to assess how risk committees have identified and addressed model risk and have they made efforts to quantify the risks.”

The midway point of the session brought in an exciting Role Play of a board meeting. The aim behind the role play was to bring out the practical aspect of the methodologies presented by Raditha in the first half of the session.

The role play gave light to many board level issues that arise in terms of governance structures and business models and the resultant negative impact on profits. Following the conclusion of the role play, Thamali and Pyumi took the center to conclude the day’s session with a presentation on Governance structures.

Thamali and Pyumi spoke of the importance of establishing the relevant KPIs required and the mechanisms to use to establish the relevant KPIs from the lending aspect of finance companies. Governance, culture and risk are three key elements that are interconnected and need simultaneous attention from decision makers in terms of implementing governance structures.

Some of the guidelines provided by Thamali and Pyumi were;

  • Front line lending officers need to be aware of the industry credit quality, pricing and should not only keep in mind the financial target to be achieved prior to lending money to burrowers. Management need to take measures and enforce necessary controls to establish broader KPIs for front line lending officers.
  • Prior to the establishment of KPIs, it is critical to identify the Key Risk Indicators, and thereby identifying the Growth Indicators. Once the growth indicators are identified, management can establish the KPIs and train front liners to gain skills on pricing mechanisms and evaluation of customers and ratings.
  • Monitoring of KPIs is one of the most neglected processes in organizations today. Decision makers need to revisit their governance frameworks and identify why monitoring is neglected to such extent.
  • Attitude and culture acts as the glue that binds the whole organization together. Without the right attitude and culture, risk appetite, budgets, KPIs or risk analysis will not deliver the intended requirement.
  • The board of directors need to provide oversight while a higher weight on governance will be borne by the Internal Audit function. Internal auditors need to provide the board with relevant information on the policies implemented and give feedback from assessing the process of validating the existing models.

Companies need to re-assess the risk appetite with consideration of the business model as it is important to align the governance and model validations with existing business models. Credit quality for lenders could improve with proper mechanisms in place to assess customers and thereby minimize risk in the portfolio.

Risk management and the finance function will need to collaborate to implement and maintain the necessary governance structures and model validations. Pricing strategies will have to reflect the risk elements associated with credit lines. With the ongoing changes, the recoveries process will have to transform to a relationship management process to ensure the control and monitoring framework is smoothly run.

Read more on the Sunday Observe article

© 2020 KPMG, a Sri Lankan partnership and a member firm of the KPMG global organization of independent member firms affiliated with KPMG International Limited, a private English company limited by guarantee. All rights reserved.


For more detail about the structure of the KPMG global organization please visit https://home.kpmg/governance.

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