Financial Institution Advantage and the Optimization of Information Processing

Chapter 3Data, Models, and Information

In this chapter, we define models and their role in information processing and in generating competitive advantage for financial institutions. We discuss model risk, and the model governance boom that began in the years before the 2008 crisis and intensified as a result of the crisis, largely under pressure from systemic regulators like the Fed. We explain why firms looking to develop long-term competitive advantages will likely view existing regulatory requirements as bare minima that can easily be met when information processing capabilities are appropriately prioritized.

Model Risk Mania

Beginning in the late 1990s and taking an enormous leap following the 2008 financial crisis, the financial services industry has been beset with demands for greater recognition of model risk, better capabilities for measuring it, and comprehensive and effective model governance. These demands have come from investors, regulators, managers, commentators, and the general public. The clear implication is that bad decisions and general mismanagement leading to huge losses and institutional collapse can be traced to a lack of quality control in the analytic layer. The fact that financial institutions had long been evolving toward a more quantitative, information-processing model was known to many observers, including bank regulators who stated in the introduction of their main model risk guidance memo that

Banks rely heavily on quantitative analysis and ...