Welcome to the latest Model Management Monday. This is the third in my blog series on model management, each post highlighting a best practice that supports both compliance and improved performance.
Best Practice #3: Ensure Segmentation Transparency
Regulators require that you clearly document how you segmented the subpopulations within your portfolio and how you determined the unique actions you take against each. You also need to demonstrate that your segmentation supports your business objectives.
Regulators will ask whether you defined your subpopulation empirically or by a domain expert, and how your segmentation fits in with your decision strategies. In some countries, you may also need to demonstrate that your segmentation does not discriminate based on age, race or gender. Basel mandates that if you segment by product, you must do it under the umbrella of Residential Mortgage (RM), Qualified Revolving Retail Exposures (QRRE) and Other Retail (OR).
The key to successful segmentation is in identifying the right variables to split a population into actionable segments that maximize the predictive power of model. Automated tools and techniques now make this process significantly faster and easier. The best solutions deliver optimized segmentation schemes that substantially improve a model's precision, while maintaining a transparent and interpretable scoring solution for use with regulators.
Remember that in order to validate and track a segmented modeling solution effectively, you will want to evaluate the entire system, as well as the individual segment models. Take care to ensure that the relationship between score and performance is consistent across segments. If your analysis shows that this is no longer the case, the model should be realigned or redeveloped.
For more details on this and other best practices, download the FICO Insights white paper, "Comply and Compete: Model Management Best Practices" or Martin Butler’s paper on Model Management and Governance.