The European Banking Authority (EBA) has published a progress report on the roadmap set out in 2016 to repair internal models used to calculate own funds requirements for credit risk under the Internal Ratings Based (IRB) approach. The roadmap aims to address the concerns about undue variability of own funds requirements and to restore trust in IRB models by ensuring comparability of the estimates of risk parameters, while retaining their risk sensitivity. This report marks the finalisation of the IRB regulatory review and provides clarity on the next steps.
The EBA’s IRB roadmap was set up to: (i) review the IRB regulatory framework, (ii) to ensure supervisory consistency, and (iii) to increase transparency. The emphasis of the EBA’s work has been mostly placed on the regulatory aspects, and this report marks the finalisation of the regulatory review of the framework, as set out originally.
The regulatory review, which includes all the EBA related guidelines and technical standards, is the result of an open and constructive dialogue with the industry and of a close cooperation with competent authorities. This report addresses concerns of both parties with regard to the implementation timelines. In this respect, to allow for a high quality implementation, the EBA has decided to extend the deadline for introducing changes in the rating systems by one year, to the end of 2021. In addition, considering the interactions with the final Basel III framework, published by the Basel Committee on Banking Supervision (BCBS) in December 2017, the EBA allowed for the changes in the loss given default (LGD) and conversion factors models for low default portfolios to be implemented by the end of 2023, at the latest.
Besides the Guidelines on credit risk mitigation (CRM), which are currently under consultation, the EBA does not intend to make any further revisions to its guidance on internal models, as set out in its roadmap. While the industry and competent authorities are implementing the regulatory review of the IRB approach, the EBA’s efforts will now focus on monitoring and exploring whether there is evidence of reduced variability of risk-weighted exposure amounts. In this area, the EBA has been performing an annual benchmarking exercise and will further develop and improve this tool through more thematic analyses and in cooperation with competent authorities. Furthermore, to support the implementation process, the EBA will also continue to use its Q&A tool.
The EBA has also started work to improve transparency through harmonised Pillar 3 disclosures, based on the revised requirements set out in the revised Capital Requirements Regulation (CRR2). In parallel, the EBA will undertake work on supervisory reporting to align it with the revised disclosure requirements. In addition, the EBA will carry out a more comprehensive review with a view to improving consistency of data requests with the definitions and clarifications developed in the regulatory review of the IRB approach. This broader work will take into account all the data requirements, including both supervisory reporting and data collected for the purpose of supervisory benchmarking.
The EBA believes that the implementation of the EBA’s bottom-up repair alongside the top-down reforms set out in the final Basel III framework will significantly reduce undue variability of own funds requirements. It is, therefore, important that the implementation efforts continue at the current high pace, ensuring continued credibility of the IRB framework.