The Board Identified Areas of Improvement for Its Supervisory Stress Testing Model Validation Activities, and Opportunities Exist for Further Enhancement. Board Report: 2015-SR-B-018 October 29, 2015

“The Office of Inspector General conducted this evaluation to assess the extent to which the Board of Governors of the Federal Reserve System’s (Board) model risk management practices in support of its supervisory stress testing efforts are consistent with supervisory guidance on model risk management previously issued by the Board. Specifically, we focused primarily on model validation activities, but we also evaluated broader governance, policies, and controls as warranted. Background – In 2010, the Dodd-Frank Wall Street Reform and Consumer Protection Act mandated that the Federal Reserve conduct annual stress tests of all bank holding companies (BHCs) with $50 billion or more in total consolidated assets. In late 2010, the Federal Reserve initiated the annual Comprehensive Capital Analysis and Review (CCAR) exercise, which includes quantitative stress tests and a qualitative assessment of the largest BHCs’ capital planning practices. CCAR has developed into the cornerstone of the Federal Reserve System’s supervisory program for the largest BHCs. Although the Board oversees supervisory stress testing, it relies on a broad range of Federal Reserve System staff to execute the program. Findings -The use of models in any environment invariably presents model risk—the risk that decision making may be influenced by inaccurate or unreliable models. The Board expects that its supervisory stress testing program will mitigate model risk in a manner consistent with the standards that the Board has outlined in relevant supervisory guidance. A guiding principle for managing model risk is model validation, which refers to the effective and independent challenge of each model’s conceptual soundness and control environment…”