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. These principles will be a part of the EBA supervisory handbook, which will be published later in 2022.
EBA clarified the requirements covering the representativeness and use of IRB-relevant data impacted by the COVID-19 pandemic and the countering measures in terms of validation and calibration. The four draft principles are based on the policy laid down in the Capital Requirements Regulation (CRR), the regulatory technical standards on assessment methodology for assessing compliance with the IRB approach requirements, and the EBA Guidelines on probability of default (PD) and loss given default (LGD). The four principles are also of general interest, especially in the context of other modeling practices, such as IFRS 9, and will allow supervisors and banks to include them in their current considerations. These principles will be incorporated in the EBA supervisory handbook that aims to clarify the existing requirements applicable for the validation of regulatory credit risk models under the IRB approach. The handbook will clarify the expectations applicable to the "validation function," both in terms of assessment of the model performance and modeling environment as well as in terms of process and governance.
The four draft principles for ensuring representativeness of the IRB-relevant data impacted by the crisis are as follows:
- The first principle clarifies that the guidance on the assessment of data representativeness laid down in the EBA Guidelines on PD and LGD should be also applied in the case of COVID-19 impacted data.
- The second principle clarifies that a significant decrease in the applied IRB risk parameters compared to the pre-crisis levels indicates a potential lack of representativeness and should be analyzed in more depth.
- The third principle deals with the default and loss rates observed during the pandemic and clarifies that in case of non-representativeness of such rates, a recalibration should be postponed to lower long-run averages.
- The fourth principle tackles the validation and recalibration of downturn LGD in the context of the COVID-19 pandemic. EBA also recommends that potential downward recalibrations be postponed at least until the effects of the crisis have fully materialized in the observed loss rates.
Keywords: Europe, EU, Banking, IRB Approach, Basel, Credit Risk, Regulatory Capital, PD, LGD, Loss Given Default, Probability of Default, Covid-19, CRR, Regulatory Technical Standards, EBA, Subheadline
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