07 August 2023
The European Banking Authority (EBA) today updated its roadmap for the implementation of internal ratings based (IRB) model requirements to limit compliance costs for institutions. The EBA also published its final supervisory handbook for the validation of internal ratings based (IRB) rating systems to clarify the role of the validation function as part of corporate governance.
In light of the upcoming implementation of the Basel III standards in the European framework, the EBA considers that the implementation of the IRB repair requirements for loss given default (LGD) and credit conversion factor (CCF) models that cover portfolios no longer eligible for the revised advanced internal ratings based (AIRB) approach in accordance with the final Basel III framework (i.e. large corporates, institutions and financial sector entities portfolios) may be postponed to the date of entry into force of the future Capital Requirements Regulation (CRR 3). Within that period, institutions may also choose to apply for permission to return to a less sophisticated IRB approach or for the permanent partial use of the standardised approach for those portfolios, according to Articles 149 and 150 of the CRR.
As already envisaged in the 2019 IRB repair progress Report, the possibility of postponing the implementation of the IRB roadmap provisions does not apply to any probability of default (PD) models, or to those LGD or CCF models that have in their scope of application exposures that may remain under the AIRB approach.
The IRB validation handbook provides guidance on the validation function, as laid out in Article 185 of the CRR. It builds on the EBA regulatory technical standards (RTS) and guidelines which are part of the IRB repair roadmap, and provides a detailed description of the areas which the validation function is expected to assess.
In particular, the handbook provides an overview of the validation framework and describes the elements where the validation function is expected to form an opinion, without prescribing any specific methodology. It covers both the tasks related to the model performance assessment, mirroring the CRR distinction between risk differentiation and risk quantification, as well those dealing with the modelling environment, such as data quality and model implementation assessment. The handbook also clarifies the relationship of the validation function with other functions related to corporate governance, such as the credit risk control unit and the internal audit.
Finally, the handbook clarifies the work of the validation function in the model cycle (i.e. first or on-going validation), as well as when using external data, outsourcing validation tasks, and in a situation of data scarcity.
The EBA task has developed a supervisory handbook in accordance with Article 8(1)(aa) of the Regulation (EU) No 1093/2010 (the ‘EBA Regulation’). The supervisory handbook aims at setting out best supervisory practices rather than provide further specifications for the application of the legislation.
The supervisory handbook is of non-binding nature, of general application and is an act of Union law whose validity can be determined only by the Union courts in a preliminary ruling. The supervisory handbook is not addressed directly to financial institutions but to competent authorities, and does not limit in any regard their judgment-led supervision.
On 9 July 2019, the EBA published its progress Report and set a new timeline for the implementation of the requirements of its so called “IRB repair” program. In particular, this Report addressed concerns with regard to the implementation timelines as they were set in 2016 in the EBA Opinion EBA/Op/2016/01). In this respect, the EBA decided to extend the deadline until the end of 2023 for LGD and CCF models that cover portfolios that will no longer be eligible for the AIRB approach under the final Basel III framework (i.e. stand-alone rating systems for exposures to institutions, financial institutions treated as corporates or large corporates as defined under the final Basel III framework).
The regulatory work on the IRB repair program ended on the 6 May 2020 with the final publication of the Guidelines on Credit Risk Mitigation for institutions applying the IRB approach with own estimates of LGDs (EBA/GL/2020/05). Since then, due to the COVID 19 pandemic, the Governors and Heads of Supervision (GHoS) announced a deferral of the calendar of the final Basel III implementation and agreed on a delay of one year for the implementation of the final Basel III standards published in December 2017.