On 19 February 2024, the European Central Bank (ECB) published its revised guide to internal models. The guide covers general topics, credit risk, market risk and counterparty credit risk. This follows a public consultation which ended in September 2023. The ECB has considered all 625 comments received from 20 respondents during the public consultation and alongside the revised guide, published a feedback statement providing an overview of the comments received and the ECB’s assessment of these comments.
Background
Articles 143, 283 and 363 of the Capital Requirements Regulation (CRR) require the ECB to grant permission to use internal models for credit risk, counterparty credit risk and market risk where the requirements set out in the corresponding chapters of the CRR are met by the institutions concerned.
The guide is intended as a document for the internal use of the different ECB supervisory teams, with the aim of ensuring a common and consistent approach to matters related to internal models. When applying the relevant regulatory framework in specific cases, the ECB will take into due consideration the particular circumstances of the institution concerned.
Key changes
The guide explains how the ECB understands the rules banks must follow when they use internal models. Supervisors check compliance with these rules and with the ECB’s permission, banks may use their own internal models to calculate their risk-weighted assets, which reflect the risks banks have on their books and serve as the basis for calculating minimum regulatory requirements. The revisions to the guide clarify how banks should go about including material climate-related and environmental risks in their models. They also outline how banks can revert to the standardised approach for calculating risk weighted assets, which may support banks’ efforts to simplify their internal model landscapes. Specifically on credit risk, the revised guide helps all banks to move towards a common definition of default and a consistent treatment of “massive disposals” (bulk sales of non-performing loans). The update of the market risk chapter details how to measure default risk in trading book positions. In addition, the revised guide provides clarifications regarding counterparty credit risk, which is the risk that the counterparty to a transaction could default.
Further information can be found on the Frequently Asked Questions webpage, which has also been updated in accordance with the revised guide.