Improving confidence in internal approaches for calculating capital requirements

Improving confidence in internal approaches for c...

Given the current lack of confidence in bank capital ratios, the Basel Committee on Banking Supervision (BCBS) is debating the future role that internal ratings-based (IRB) models should play within the regulatory capital framework. A plan for improving IRB will be published by the G20 summit in November 2014.


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In 2015 the BCBS also intend to publish:

  • Trading book reforms covering constrains on both model-generated risk weighted assets (RWAs) and arbitrage optionality between banking and trading books (including whether interest rate risk should become a Pillar 1 charge in the banking book); and
  • A review of the standardised approach to calculating RWAs.

European legislators have also acknowledged the need to constrain the inconsistent calculation of risk-weighted assets for equivalent portfolios. Therefore, in response to Article 78 of the Capital Requirements Directive (CRD) the European Banking Authority (EBA) has issued a consultation on benchmarking internal approaches for calculating capital requirements. This will require competent authorities to assess, at least annually, the consistency and comparability in risk-weighted assets (RWA) produced by institutions’ internal modelling approaches (except for operational risk).

The consultation specifies the:

  • Benchmarking portfolios
  • Templates, definitions and IT solutions to be applied for market and credit risk
  • Standards for the assessment of the internal approaches applied to calculating own funds for market risk, counterparty risk internal models (IMM), credit valuation adjustment (CVA) and credit risk.

Apart from capturing the most global and common risk factors included in the portfolios for internationally active banks, the EBA intends to assess EU local banks which might be largely focused in local non-euro markets. As a starting point it is proposed to carry out an in-depth assessment in Denmark, Sweden and the UK which all have internal model banks.

Given the potential impact of changes to current capital requirements, European banks should understand what is coming, especially as some competent authorities tighten up requirements for modelling approaches and encourage certain firms onto standardised approaches.

For more information, please visit the European Banking Authority website.

Further insights

To discuss this issue further, please contact:

Andrew Davidson

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