Andreas Dombret of Bundesbank on Internal Models in Banking Regulation
Andreas Dombret, Member of the Executive Board of the Deutsche Bundesbank, spoke at the EBA Policy Research Workshop about the future of internal models in banking regulation. He highlighted the limitations and strengths of internal models and outlined his take on where the current and future EU projects on internal models should be heading.
Mr. Dombret discussed the benefits of internal models and their state before and after the financial crisis. He further noted that models can never get a calculation fully right. Limiting mis-measurement requires dealing with risk and uncertainty. He noted that internal models played an important role in the Basel III finalization package, even though they have rightfully lost their sacrosanct status, as they revealed big weaknesses during the last financial crisis. Models will never be perfect and there must be awareness about the underlying assumptions and their shortcomings. After regulatory reform, internal models rightly continue to play a big role, but now a complementary one. Limits have been set. However, we shouldn't overreact. It is also important to maintain incentives for banks with regard to a risk-sensitive framework. This is why, on the Basel Committee, German authorities have resolutely argued in favor of sufficient incentives for internal models. On the basis of the limits set by the Basel III reforms, we must to look forward now, said Mr. Dombret. National competent authorities, EBA, and Single Supervisory Mechanism (SSM) must work on improving internal models further so that they can contribute to efficient and stable financial markets.
He highlighted the need to support the benefits of internal models. He emphasized that banks have to build better models, models that not only focus on the efficient use of capital but also ensure that a bank can weather future storms. With regard to credit risk and the boundaries for the internal ratings-based (IRB) approaches, it is important to implement the Basel III compromise in a rigorous way. He mentioned, "Another important point concerns credit risks, but also other risk type models. The targeted review of internal models, the TRIM project, by the SSM should be conducted in a responsible and considered manner...." This means the biotope of risk modeling approaches must be kept diverse. A right understanding of harmonization means not only treating equal things equally, but also treating unequal things unequally. TRIM must ensure, that the playing field for banks is leveled, but not create a monoculture of models driven by supervisory rules. The changes that will be introduced through the TRIM project must be implemented reasonably. Banks need a transitional period to adopt the new standards. In the end, he reiterated, "You have a full agenda of challenges in risk modeling ahead of you. Moreover, during the coming years, you, hopefully, will help to make financial risk models better."
Related Link: Speech
Keywords: International, Banking, Internal Models, IRB Approach, Banking Regulation, TRIM, Bundesbank, BIS
Related Articles
SEC Finalizes Climate-Related Disclosures Rule
The U.S. Securities and Exchange Commission (SEC) has finalized the long-awaited rule that mandates climate-related disclosures for domestic and foreign publicly listed companies in the U.S.
US Regulators Release Stress Test Scenarios for Banks
The U.S. regulators recently released baseline and severely adverse scenarios, along with other details, for stress testing the banks in 2024. The relevant U.S. banking regulators are the Federal Reserve Bank (FED), the Federal Deposit Insurance Corporation (FDIC), and the Office of the Comptroller of the Currency (OCC).
Asian Governments Aim for Interoperability in AI Governance Frameworks
The regulatory landscape for artificial intelligence (AI), including the generative kind, is evolving rapidly, with governments and regulators aiming to address the challenges and opportunities presented by this transformative technology.
EBA Proposes Operational Risk Standards Under Final Basel III Package
The European Union (EU) has been working on the final elements of Basel III standards, with endorsement of the Banking Package and the publication of the European Banking Authority (EBA) roadmap on Basel III implementation in December 2023.
EFRAG Proposes XBRL Taxonomy and Standard for Listed SMEs Under ESRS
The European Financial Reporting Advisory Group (EFRAG), which plays a crucial role in shaping corporate reporting standards in European Union (EU), is seeking comments, until May 21, 2024, on the Exposure Draft ESRS for listed SMEs.
ECB to Expand Climate Change Work in 2024-2025
Banking regulators worldwide are increasingly focusing on addressing, monitoring, and supervising the institutions' exposure to climate and environmental risks.
BIS Bulletin Examines Cognitive Limits of Large Language Models
The use cases of generative AI in the banking sector are evolving fast, with many institutions adopting the technology to enhance customer service and operational efficiency.
ECB is Conducting First Cyber Risk Stress Test for Banks
As part of the increasing regulatory focus on operational resilience, cyber risk stress testing is also becoming a crucial aspect of ensuring bank resilience in the face of cyber threats.
EBA Continues Momentum Toward Strengthening Prudential Rules for Banks
A few years down the road from the last global financial crisis, regulators are still issuing rules and monitoring banks to ensure that they comply with the regulations.
EU and UK Agencies Issue Updates on Final Basel III Rules
The European Commission (EC) recently issued an update informing that the European Council and the Parliament have endorsed the Banking Package implementing the final elements of Basel III standards