Applying Modeling and Validation
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Applying Modeling and Validation

New applications and techniques for quantitative modeling are emerging rapidly in areas ranging from financial risk modeling to consumer protection and compliance. Promontory quantitative specialists are in tune with these new developments, and can provide unparalleled advice on when such techniques are likely to bring meaningful, practical benefits and materially contribute to the solution of business problems.

 

Whether we are providing advice on approaches and methodology, developing new models, or validating existing models, Promontory brings the same depth of skill and insight to bear. We ensure that solutions in any area of modeling are fully consistent with sound practices, applicable regulatory requirements, and supervisory expectations.

Financial Risk Modeling

Financial risk modeling is at the core of our practice. While risk is typically defined as some measure of financial loss, the means by which such losses arise include failure to repay or perform (credit and counterparty risk); the failure of support systems, processes, or people (operational risk); or unexpected changes in value due to market factors.

Credit Risk

Whether a client is interested in ranking the risk of various obligors or evaluating the expected loss of a loan portfolio, Promontory can help. Our areas of specialty include:

  • Risk rating and scoring
  • PD, LGD, and EAD
  • Expected loss / ALLL
  • Point-in-time versus through-the-cycle modeling
  • Risk-adjusted loan pricing
  • Transition modeling
  • Top-down versus bottom-up techniques

Market Risk

Whether a bank needs assistance simulating the path of its market exposures or estimating the impact of extreme events, we can help. Our areas of specialty include:

  • Value at risk
  • Expected shortfall
  • Credit valuation adjustment
  • Interest-rate risk

Operational Risk

Given the susceptibility of firms to losses related to people, internal processes, and external events, operational risk poses a significant threat. We are well versed in the debate between the industry and supervisors over the use of internal models to measure operational risk. Our services include:

  • Advanced measurement approach
  • Loss-distribution analysis
  • Scenario analysis
  • Application of external loss data
  • Application of business-environment and internal-control factors
  • Extreme-value theory

Valuation and Pricing

Valuation and pricing methodologies are an important consideration in financial reporting and risk management. The approach taken to valuing a security can often have a direct impact on both a firm’s capital requirements and its reported profitability. Accordingly, the quantitative services team assists clients with the application of the following techniques:

  • Discounted cash flow
  • Contingent cash flow
  • Discrete time pricing
  • Continuous time pricing

In addition to pricing methodologies, we have extensive business knowledge pertaining to a range of financial instruments. Our areas of specialization include:

  • Structured products
  • Swaps
  • Futures and forwards
  • Options
  • Loans
  • Hybrid securities

Stress Testing and Capital Planning

Promontory conducts high-quality engagements on capital planning and stress testing. We understand the need to develop sophisticated solutions that comply with regulations but avoid excessive complexity. We also understand that clients want to leverage prior investments in capital planning and develop stress-testing solutions that support meaningful risk management. At the same time, we have observed that clients:

  • May have good available data on their loan portfolios and charge-off histories to support credit modeling, but that existing credit-loss models may need enhancements before use in regulatory stress tests
  • Often need to address interest-rate risk and liquidity stresses that may be unique to their business models
  • May need to broaden scenarios to include relevant risk drivers and other variables
  • Usually need to further enhance model documentation and validation

Promontory’s depth of skills and knowledge allows us to tackle all of the above challenges. Our areas of expertise include:

  • Loss forecasting
  • PPNR modeling
  • Balance-sheet forecasting
  • Contingent-capital modeling
  • RWA forecasting
  • Scenario design

Compliance Modeling

Quantitative techniques are essential tools for monitoring regulatory compliance. For example, Bank Secrecy Act anti-money-laundering requirements warrant implementation of sophisticated transaction-monitoring systems, and fair-lending regulations require banks to provide statistical evidence that their lending practices are nondiscriminatory. Promontory’s deep regulatory expertise, combined with the quantitative services team’s technical acumen, makes us the premier provider of compliance modeling services.

AML Compliance

The introduction of disruptive technologies and the growth of global terrorist organizations have reinforced AML compliance as a regulatory priority. Authorities are focusing on the techniques banks use to implement transaction-monitoring systems. When helping implement an AML transaction-monitoring system, Promontory has two key goals in mind:

  • System effectiveness — finding suspicious activity when it is present
  • System efficiency — minimizing the number of false-positive cases that require investigation

Our areas of specialization include:

  • Using our proprietary system for ranking suspicious-activity reports
  • Reviewing the design and performance of clients’ transaction-monitoring systems and conducting calibration testing
  • Assessing system design, calibration-testing thresholds, and rules for risk-level suitability and soundness
  • Verifying monitoring systems’ data against source data
  • Assessing whether monitoring-system rules and triggers are correctly implemented and calibrated

Fair Lending and Consumer Compliance

Fair lending and other, similar programs are vital for ensuring that an institution serves all customers without regard to protected-class characteristics. When reviewing fair-lending compliance, banks must use a combination of qualitative and quantitative techniques to investigate potential disparate treatment of borrowers or disparate impact of bank policies on lending decisions.

Our areas of specialization include:

  • Creating and applying statistical techniques for analyzing loan pricing and approval patterns
  • Replicating the quantitative methodologies applied by regulators
  • Performing deeper analysis of consumer data and results

Engagement Case Studies

Click here to download a PDF featuring selected case studies of quantitative services engagements.

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