Model Risk

The use of models invariably presents model risk, which is the potential for adverse consequences from decisions based on incorrect or misused model outputs and reports.

The credit union’s asset liability model used to generate IRR measurements is based on simplified algorithms representing the complex interrelationships among a list of variables. Assumptions based on past behavior, such as how quickly a credit union will reprice its assets and liabilities given changes in interest rates and competitive forces, may not accurately predict future behavior. Using unreliable assumptions may result in inaccurate estimates of a credit union’s risk to earnings and available liquidity.

Model risk increases with model complexity and with higher levels of uncertainty about the validity of inputs and assumptions. Credit unions should conduct model risk management to address these risks. This may include robust model development, a sound model validation process, and an effective governance framework that defines roles and responsibilities for clear communication of model limitations and assumptions.

The FRB and OCC have issued supervisory guidance on model risk management.

Last updated on December 06, 2024