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Regulatory review of IRB approach

Regulatory review of IRB approach

Based on the discussion paper on ‘The Future of the IRB Approach’ published on 4 March 2015 the European Banking Authority (EBA) published on 4 February 2016 a report containing a summary of responses received from the industry as a reaction to the discussion paper. In the report the EBA also outlined its final plans relating to the regulatory review of the IRB approach and implementation of the changes in IRB models. Moreover, the report provides preliminary EBA view on possible changes in the Basel framework. Generally, the EBA's work will provide clarifications on technical aspects of IRB models and should not interfere with the Basel expected outputs. On one hand, this EBA effort should contribute to a higher degree of comparability of capital requirements including the increase of supervisory consistency. On the other hand, the EBA reiterates that it is in favour of the continued use of the IRB approach which should preserve its high degree of risk-sensitivity. Furthermore, the EBA believes that the outlined regulatory review must be later supplemented by changes to the underlying legal Framework to reduce undue variability. At least at first sight it may seem that EBA is trying to achieve two inconsistent objectives. Thus the practical approaches of supervisors will be crucial. The EBA in the report justifies a partial reduction in modelling options, in particular in the area of LGD modelling for low-default portfolios.

The EBA intends to complete the regulatory review in four phases based on the existing EBA mandates in the CRD/CRR legal framework to develop technical standards and Guidelines to supplement the primary legislation:

  • Phase 1: Assessment methodology
  • Phase 2: Definition of default
  • Phase 3: Risk parameters
  • Phase 4: Credit risk mitigation

The timelines originally proposed in the discussion paper were extended to be more realistic in practical terms and to ensure consistency with the changes expected in the Basel framework.

The EBA in the report draws three conclusions as regards its future policy. In terms of implementation by institutions, the EBA expects a dialogue with the supervisor to agree on an implementation plan during 2016 and 2017. Nevertheless, the institutions must finalise the implementation of the changes in their models and processes by the end of 2020 at the latest. The EBA took into account both the operational burden related to the changes in the rating systems and the supervisory approval processes as the originally proposed deadline in the discussion paper was 2018.

The report is supplemented by an EBA opinion and both documents should be read jointly. The Opinion also contains the EBA work plan, but in addition addresses the practical concerns raised by respondents about implementation of the proposed changes.