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The ECB has published an updated version of its "Guide to internal models" with guidance for financial institutions on the use of internal models for calculating regulatory capital requirements across various risk types: credit risk, market risk, and counterparty credit risk.
The European Central Bank has tightened its guidance on how banks model credit risk, sharpening expectations across governance, validation, and risk parameter estimation. The revised rules scrap the minimum 50% rollout of internal ratings-based models, giving banks more flexibility but also more scrutiny over how they choose approaches. Senior managers and boards are now directly accountable for model quality and timeliness, while validators and auditors face tougher independence and rigor requirements. Definitions of default, rules on overrides, and the calibration of probability of default, loss given default, and credit conversion factors have all been clarified, narrowing discretion and aligning models with stricter benchmarks.
The thrust is clear: models must be more transparent, comparable, and conservative. Banks will have to justify assumptions against historical data and reference values—often lifting capital needs—while supervisors push internal models away from opaque discretion and toward a common regulatory standard.
In the revised guide, the chapter on credit risk includes:
This blogpost focuses on the key updates, discussing the implication to the institutions’ internal models, and providing recommendations to comply with the refined regulation.
To summarize, the ECB’s revised guide to internal models refines the expectation for credit risk models. Institutions should incorporate the newly defined requirements in their internal model calibration / assessment, thoroughly assessing if their models need to be adjusted to comply with the updated regulations.
In terms of estimation of risk parameters, institutions might need to pay particular attention to the refined requirement on the selection of historical observation period for the calculation of LRA estimates, as well as the comparison between reference value and LRA DR / final LGD estimates.
At Finalyse, our goal is to support banks and financial institutions in developing and refining the risk models to fulfil the regulatory expectations. Our team has significant expertise in both regulatory and non-regulatory models with deep knowledge of supervisory requirements.
What we offer to you:
If you would like to talk about these points, we would be glad to discuss how we can support your institution.
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A tool for banks to validate the implementation of RWA calculations and be better prepared for CRR3 in 2025
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