Why Financial Analytics expertise is going to be the next big thing!

Snehamoy Mukherjee


July 19th, 2012

While everyone believes that “Big Data” is the next big thing in the world of Analytics, I believe otherwise. There is a reason why every person who is in the Financial Services domain and with an interest to pursue Analytics should be extremely excited about. There is a new stream of work which is picking up steam in a big way and people who train themselves to develop relevant expertise, will be in great demand. The other important aspect of this work is that it will need to be repeated on a regular basis (in some cases, 6 months and in others annually). The demand for this will only increase and not decrease, as more Financial Institutions are added to the list of those needing to fulfill certain requirements from Financial Regulatory Organizations across different countries. This new stream of work is called “Model Validation” and it will give rise to a new breed of auditors called “Model Validators”.

Now let me explain why this competency is going to become so important. The US Fed (Federal Reserve Board) is required under the Dodd Frank Wall Street Reform and Consumer Protection Act to conduct an annual Comprehensive Capital Analysis and Review (CCAR) on large, complex bank holding companies. 19 companies are required to participate in this year’s CCAR. The Fed takes each company’s “unique risks” into account and makes sure each has “sufficient capital to continue operations throughout times of economic and financial market stress.” Essentially, CCAR (see-car) is the Stress Testing requirement that Fed regulated as an annual requirement across all the 19 big banks. In fact, some big insurance companies are expected to be compliant to this/similar requirement. Fed provides four scenarios,” baseline”, “worsening”,” adverse” and “severe”, under which banks have to show the risk-based capital required to remain solvent (99.5% probability of surviving).CCAR is currently an annual requirement and may become a 6-month requirement. At present, every year, each bank is required to submit schedules to the Fed about the cash-flow for simulations under the four scenarios.

As a part of the above, there are underlying loss-forecasting models that need to be audited. These models typically forecast losses over the next 3-5 years. It has thus become imperative for the big Banks to hire external auditors to perform these tests and validations so that the Fed requirements are met and are water tight.

It is also expected that more and more financial institutions will be subject to similar scrutiny in the coming years in the US. Other Banks and Financial institutions across the world are taking the cue from US and are coming up with their own set of risk compliance, which essentially means huge amounts of auditing or validation of models built by their internal teams.

The other reason why Financial Analytics expertise will become extremely sought after is one which most of us are aware of- it is the set of regulations that have been issued by the Basel Committee on Banking Supervision. We now have Basel-III, in the line of Basel Accords that have been passed so far. Prior to 2008, it was difficult to implement Basel, but once that year’s major banking crises unfolded, most countries have now mandated their Banks to implement the Basel Accord. To quote from Wikipedia – “Basel II, initially published in June 2004, was intended to create an international standard for banking regulators to control how much capital banks need to put aside to guard against the types of financial and operational risks banks (and the whole economy) face. One focus was to maintain sufficient consistency of regulations so that this does not become a source of competitive inequality amongst internationally active banks. Advocates of Basel II believed that such an international standard could help protect the international financial system from the types of problems that might arise should a major bank or a series of banks collapse. In theory, Basel II attempted to accomplish this by setting up risk and capital management requirements designed to ensure that a bank has adequate capital for the risk the bank exposes itself to through its lending and investment practices. Generally speaking, these rules mean that the greater risk to which the bank is exposed, the greater the amount of capital the bank needs to hold to safeguard its solvency and overall economic stability.”

Most banks in most countries are now in the preliminary stages of implementing these requirements. The floodgates for Analytics resources with knowledge of Regulatory Requirements, with knowledge of Modeling Techniques fulfilling the regulations and the ability to audit models built by others, will open up very soon.

The expertise required would include:

  1. Audit of existing models
  2. Audit of data collection methodologies and processes
  3. Audit of data processing
  4. Audit of data cleaning
  5. Audit of data aggregation
  6. Audit of data integration
  7. Conceptual validation of models built from a logical and regulatory perspective
  8. Extensive knowledge of regulatory requirements

A new breed of Auditors would thus come into being. Are you ready for this next big explosion? If not, register for the Financial Analytics Course in Jigsawacademy.com to get an early lead in this front.

Image courtesy of Natara at FreeDigitalPhotos.net
Image courtesy of Natara at FreeDigitalPhotos.net

Related reads:

Building a career in Financial analytics

Understanding Credit Risk Analytics


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