EBA Issues Standards on Capital Requirements for Non-Modellable Risks
EBA published the final draft regulatory technical standards on the capitalization of non-modellable risk factors (NMRFs) for institutions using the Internal Model Approach under the Fundamental Review of the Trading Book (FRTB) implemented in EU as a reporting requirement. The draft standards lay down a methodology for use by institutions to determine the own funds requirements related to non-modellable risk factors in the new market risk regime. The standards set out how institutions are to determine the stress scenario risk measure corresponding to a non-modellable risk factor. The development of these regulatory technical standards fulfills an EBA mandate under the revised Capital Requirements Regulation (CRR2).
The regulatory standards set out methodologies that institutions are required to use to determine the extreme scenario of future shock that, when applied to the non-modellable risk factor, provides the stress scenario risk measure. These standards require institutions to identify a stress period for each broad risk-factor category and to collect data on non-modellable risk factors for the stress period, to determine an extreme scenario of future shock. Once the stress period is identified, institutions can use the following methods:
- The direct method, which involves directly calculating the expected shortfall measure of the losses that would occur when varying the given risk factor as in the relevant stress period
- The stepwise method, wherein institutions approximate the expected shortfall of the losses by first calculating a shock calibrated to an expected shortfall measure on the returns observed for that risk factor and then calculating the loss corresponding to the movement in the risk factor identified by that calibrated shock
The stepwise method requires significantly fewer loss calculations than the direct method. The computation of the calibrated shock for returns under the stepwise method depends on the number of observations available for the stress period. The draft standards also clarify how this has to be done when the number of observations for a non-modellable risk factor is insufficient to obtain meaningful statistical estimates. Additionally, these draft regulatory technical standards specify:
- A regulatory extreme scenario of future shock that should be applied where the institution is unable to determine a scenario based on the abovementioned methodologies, or where the competent authority is unsatisfied with the extreme scenario of future shock generated by the institution
- That the regulatory extreme scenario of future shock is the one leading to the maximum loss that can occur due to a change in the non-modellable risk factor and they set out a specific framework to be used where that maximum loss is not finite
- That institutions may calculate a stress scenario risk measure at regulatory bucket level (that is, for more than one risk factor), where the institution uses the regulatory bucketing approach to assess the modellability of the risk factors within the regulatory buckets
- The formula that institutions should use when aggregating the stress scenario risk measures
These draft standards are one of the key deliverables in the EBA work on implementing the revised market risk framework in EU and as part of the roadmap for the new market and counterparty credit risk approaches that were published on June 27, 2019. EBA had launched, in July 2019, a data collection exercise presenting several stress scenario risk measure calculation method variants. The purpose of the data collection exercise was to apply the EBA non-modellable risk factor methodology proposals that were proposed in the discussion paper toward implementation of the revised market risk and counterparty credit risk frameworks in EU. Post which, in June 2020, EBA had published the consultation paper on which these final draft technical standards are based. Thus, the proposed regulatory technical standards are the result of an iterative process where the views of market participants have been sought several times.
Related Links
Keywords: Europe, EU, Banking, Market Risk, FRTB, Regulatory Capital, Basel, NMRF, Regulatory Technical Standards, CRR2, Internal model, EBA
Previous Article
EBA Explains Methodology for Assessing AML/CFT RisksRelated Articles
EBA Clarifies Use of COVID-19-Impacted Data for IRB Credit Risk Models
The European Banking Authority (EBA) published four draft principles to support supervisory efforts in assessing the representativeness of COVID-19-impacted data for banks using the internal ratings based (IRB) credit risk models.
BIS Hub Updates Work Program for 2022, Announces New Projects
The Bank for International Settlements (BIS) Innovation Hub updated its work program, announcing a set of projects across various centers.
US Senate Members Seek Details on SEC Proposed Climate Disclosure Rule
Certain members of the U.S. Senate Committee on Banking, Housing, and Urban Affairs issued a letter to the Securities and Exchange Commission (SEC)
EIOPA Consults on Review of Securitization Framework in Solvency II
The European Insurance and Occupational Pensions Authority (EIOPA) published a consultation paper on the advice on the review of the securitization prudential framework in Solvency II.
UK Authorities Issue Regulatory and Reporting Updates for Banks
The Prudential Regulation Authority (PRA) issued a statement on PRA buffer adjustment while the Bank of England (BoE) published a notice on the statistical reporting requirements for banks.
BaFin Consults on Resolvability Requirements for Resolution Planning
The Federal Financial Supervisory Authority of Germany (BaFin) proposed to amend the “Capital Investment Conduct And Organization Ordinance” and issued a draft circular on the minimum resolvability requirements for resolution planning.
EBA Consults on Certain Standards and Guidelines Under CRR and BRRD
The European Banking Authority (EBA) proposed guidelines, for the resolution authorities, on the publication of the write-down and conversion and bail-in exchange mechanic, with the comment period ending on September 07, 2022.
OJK Publishes Regulatory Updates for Financial Sector Entities
The Financial Services Authority of Indonesia (OJK) is strengthening cooperation with the Australian Prudential Regulation Authority (APRA) and the Japanese Financial Services Agency (JFSA)
EU Publishes Rules on DLT and Data Governance
The European Parliament and the Council published Regulation 2022/868 on European data governance (Data Governance Act).
EBA Publishes Phase 2 of Reporting Framework 3.2
The European Banking Authority (EBA) published phase 2 of its reporting framework 3.2. The technical package supports the implementation of the updated reporting framework by providing standard specifications