On 18 September 2020, the European Central Bank (ECB) published its finalised guide outlining the methodology it uses to assess how euro area banks under its supervision calculate their exposure to counterparty credit risk (CCR) and advanced credit valuation adjustment (CVA) risk, following a public consultation which ended on 18 March 2020.

The Capital Requirements Regulation (CRR) requires model approval for new models of any risk type and for material model extensions and changes to credit, operational and market risk internal models. The ECB guide to internal models sets out the ECB’s understanding of the applicable rules for relevant internal model areas, especially in terms of potential model variability. The ECB guide on materiality assessment sets out the ECB’s understanding of the applicable rules for model extensions and changes in the field of CCR.

The European Banking Authority (EBA) is mandated to develop regulatory technical standards (RTS) for an assessment methodology that Member State competent authorities are to apply when assessing a financial institution’s compliance with the requirements to use an internal ratings based (IRB) approach for credit risk, an advanced measurement approach for operational risk and an internal model approach (IMA) for market risk. The adoption of similar RTS for the assessment methodology for the internal model method (IMM) and the advanced method for own funds requirements for credit valuation adjustment risk (A-CVA) is not mandated by the CRR although it is possible that the EBA may adopt guidelines or RTS based on any future EU legislation.

The document now published by the ECB introduces an assessment methodology for the IMM and the A-CVA. The guide is to be applied in the context of any CCR-related internal model investigation – before or after approval – and the ongoing monitoring of approved internal models, and outlines for supervisors how the ECB intends to investigate compliance with the existing legal framework when performing these tasks. It also provides optional guidance to significant institutions on the self-assessment of their IMM and A-CVA models.