21 Hoosier Banker March 2016 2. If so, by how much? 3. What inputs, assumptions or dynamics might explain the variance (e.g. time lags, the competitive environment, changes in the local economy, etc.)? The ultimate objective of a back test is to give guidance as to if and how management could adjust current assumptions within the A/L model in order to more accurately represent the performance trends of the bank. A back test, unlike model validation, does not need to be performed by an outside auditor. The back test may be done internally or with support from the vendor or model provider. In either case, back testing should be performed, assumptions should be reviewed, and adjustments should be made when necessary. What Is Validation? Validation, in contrast to back testing, is completely different – validation is the audited process of “validating” the functionality and completeness of an A/L model. The validation process is essentially an independent review of the logical and conceptual soundness of the model. This involves scrutinizing the methodology and mathematical calculations that are built into the program. The cost of validation need not be incurred by the bank. Rather, the software vendor or provider of the model should make available a certification letter or proof of validation regarding the integrity of the model. The Regulatory Emphasis on Corporate Governance Regulators have placed greater scrutiny on ALCO processes since the last recession. Indeed, each bank is expected to conduct an “independent ALCO review,” which is a general audit of the overall policies, tools and procedures used by the bank to define, measure and manage interestrate risk. Back testing of reports and model validation are two of the key ingredients necessary for sound ALCO processes at any bank. t Chicago Indianapolis St.Louis Milwaukee 201 NORTH ILLINOIS STREET, SUITE 1400 CAPITAL CENTER, SOUTH TOWER INDIANAPOLIS, INDIANA 46204-4212 T: 317.464.4100 • F: 317.464.4101 • SALAWUS.COM Locally Sourced, Handpicked Lawyers Growing in Indiana to meet your company’s legal needs A FULL SERVICE business law firm with a simple promise – PUT YOU FIRST MARTHA LEHMAN LARRY TOMLIN JOHN TANSELLE STEPHEN STITLE DEBRA MASTRIAN MARK WENZEL The Indiana Bankers Association has been named the presenting sponsor of the official Indiana bicentennial medal, entitling IBA-member banks to serve as exclusive distribution points for medal order forms. Order form kits have been provided to all member banks; additionally downloadable promotional materials are available at: indianabankers. org/bicentennial. For questions or more information, please contact IBA’s Christina Bennett at 317-387-9380, email: cbennett@ indianabankers.org. t IBA Sponsors Bicentennial Medals
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