CP10 (Full Document) - European Banking Authority

128. The EU Council has proposed that, for institutions applying for the
use of the IRB Approach before 2010, the three­year use
requirement prescribed in Article 84(3) may, until 31 December
2009, be reduced to a period not shorter than one year, subject to
the approval of competent authorities. Similarly, for institutions
applying for the use of own estimates of LGDs and/or conversion
factors, the three­year use requirement prescribed in Article 84(4)
may, until 31 December 2008, be reduced to two years.
129. Article 84(2)(b) implies that rating systems, ratings, and default and
loss estimates designed and set up with the exclusive aim of
qualifying for the IRB, and used only to produce the data necessary
for the IRB approach, are not allowed. While ratings and default and
loss estimates must play an essential role in the relevant processes
of the institution, this does not mean that they must be in every case
be the exclusive information or the final parameters used for internal
purposes such as pricing. Nevertheless, institutions should be
required to demonstrate that those ratings and estimates play an
essential role in the processes and functions listed in Article
84(2)(b), and they should indicate where different final parameters
are used internally. When there are differences, banks should assess
them and indicate their relevance to supervisors.
130. Supervisors should distinguish between two aspects of the use test
when assessing an institution’s compliance with Article 84(2)(b):
· scope
· use of data for internal purposes
Scope
131. An institution’s rating systems and processes and its internal ratings
and default and loss estimates should be an integral part of its
business and risk management culture.
132. Institutions should make effective use of internal ratings and
resulting risk parameters. Ratings and risk parameter estimates used
in calculating capital requirements must play an essential role in the
risk­management and decision­making process, and in the credit
approval, internal capital allocation and corporate governance
functions of the institution. If not all these processes and functions
are based solely on ratings and risk parameter estimates used in
calculating capital requirements, at least an effective and material
part of them must be, so that the ratings and risk parameter
estimates used in calculating capital requirements have a substantial
influence on the institution’s decision­making and actions.
Institutions will ensure that the use of these data is not marginal,
and will assess the validity of differences, e.g., between a pricing PD
and the rating PD. Supervisors can stress that risk management
elements such as ratings or internal reporting need to be strongly
linked with ratings and risk parameter estimates used in the
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