ESBG responds to the ECB consultation on its Guide to Internal Models

On 15 September 2023, ESBG responded to the European Central Bank (ECB) public consultation on its revised Guide to internal models. The Guide clarifies how banks should go about including material climate-related and environmental risks in their models. It also provides clarifications for banks that wish to revert to the standardised approach for calculating their risk-weighted assets. On credit risk, the guide helps all banks to move towards a common definition of default and a consistent treatment of massive disposals. The update of the market risk chapter details how to measure default risk in trading book positions. The Guide also provides clarifications regarding counterparty credit risk.

Generally speaking, the revised Guide is very prescriptive in relation to the documentation to be provided in the application for reversion to less sophisticated methods, but it does not explain how the ECB will make its assessment. More clarity would therefore be needed.

Among other technical points, ESBG stressed that in the event of a model change, it should be sufficient to provide the functional and technical implementation concepts including for systems testing as evidence for the ability to provide a new version of the relevant IT systems.

We consider the introduction of a new type of obligor as inconsistent with the currently applicable Article 147 CRR unless the concept of joint credit obligations (JCOs) is fully reflected in internal risk management practices. The added complexity seems redundant from a risk quantification perspective.

On model-related margin of conservatism (MoC), the requirements regarding internal model validation should not apply at the level of the third party-provider but only at the level of the individual rating model.

Moreover, due to an inconsistency with CRR, it is also necessary to clarify that the estimate credit conversion factor (CCF) should be computed as “default weighted average resulting from all observed defaults within the data sources”.

Finally, the implementation of an alternative days past due counter for any country not within the SSM responsibility would be a very high effort that does not justify the minor improvements in credit risk steering, A more flexible, potentially conservative, formulation could be found.

Looking ahead, ESBG will continue to closely monitor the ECB work on its revised Guide.