CP10 (Full Document) - European Banking Authority

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grades and risk parameters are expected to vary with movements in the general economic cycle or more specific cycles relevant to each risk parameter. These should include descriptions of how, if at all, rating assignments and risk parameter estimates are impacted by the application of conservatism. 328. When an institution uses different rating systems characterised by different philosophies, care must be taken in the use of information, either for rating assignments or estimates, from another (internal or external) rating system that has a different rating philosophy. An example is the use of rating information or default experience obtained from rating agencies. · When an institution uses different rating systems with different characteristics (for example, different philosophies, levels of objectivity, accuracy, stability, or conservatism) it must ensure that they have an appropriate level of consistency and/or that the differences between them are well understood. This understanding should at least enable the institution to define an appropriate way to combine/aggregate the information produced by the different rating systems when this is necessary. The assumptions and potential inaccuracies arising from such a combination/aggregation should be fully understood. 329. For example, the institution should at least describe how the combination of information from rating systems characterised by different philosophies impacts the dynamics and volatility of capital requirements. · Historical data are an important source of information for constructing estimates of future default frequencies and losses, but they are only a starting point and must be adjusted with care. The minimum data periods (five or seven years) determine how much (minimum) historical experience is needed as an input to the forwardlooking estimates, and are not meant to imply that an average of actual experience is a sufficient measure for the forwardlooking estimates. Nevertheless, where an institution can demonstrate that the historical experience is likely to be an accurate estimate of the forwardlooking estimate, little or no adjustment may be needed. · Forwardlooking estimates can be lower than actual historical experience. This may be because of small sample size, because the historical experience contains a disproportionate number of extremely bad years, or because practices have changed. However, a high burden of proof would be placed on any institution that sought to ignore or significantly underweight some of the available data. · PD estimates must be based on the longrun average of default rates in each grade or pool. This implies that the historical experience needs to include a representative mix of good and bad Page 78 of 123
years for the economy as a whole, as well as addressing more specific (e.g., industry) cycles that are material to the level and volatility of defaults in exposures covered by the rating system. Institutions must demonstrate that the estimates they are using are representative of likely longrun rates. Where (internal or external) statistical prediction models are used, this may require an adjustment to the calibration of those models. · Similar considerations apply to estimates of LGD and CF based on defaultweighted averages. These averages will naturally be oriented towards the losses expected to be incurred (or the appropriate CF) under conditions when defaults for the exposures in question are expected to be high, as opposed to more normal market conditions. This should encourage more stable estimates. · Institutions should have policies and standards covering the levels of accuracy (and, where relevant, discriminative power), the acceptable levels of divergence from the expected performance, and the action to be taken when these acceptable levels are breached. They should also have clear policies for the circumstances in which these standards may be changed. Principle 2: The credit institution has primary responsibility for validation 330. Supervisors do not have the primary responsibility for validating credit institution rating systems. Rather, a credit institution has the primary role, and consequently must validate its own rating systems to demonstrate how it arrived at its risk estimates and confirm that its processes for assigning risk estimates are likely to work as intended and continue to perform as expected. Supervisors, on the other hand, should assess the credit institution’s validation processes and outcomes and may rely upon additional processes of its own design, or even those of third parties, in order to have the required level of supervisory comfort or assurance. Principle 3: Validation is an iterative process 331. Validation is likely to be an ongoing, iterative process in which institutions and supervisors periodically refine validation tools in response to changing market and operating conditions. Institutions and supervisors will need to engage in an iterative dialogue on the strengths and weaknesses of particular rating systems. · Institutions will need to adjust and improve their validation techniques in response to changing practices in the industry and as more data becomes available. Principle 4: There is no single validation method 332. While some validation tools (e.g., backtesting, benchmarking, replication, etc.) may prove especially useful, there is no universal Page 79 of 123
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CEBS CP 10 11 July 2005 Guidelines
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ANNEXES ...........................
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to use these approaches. 6. The gui
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IRB approach can be given only if t
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approaches for regulatory purposes
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purposes, when the group has submit
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efficient running of the process, u
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and/or 105 of the CRD, subject to t
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58. Institutions intending to move
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translated, supervisors will organi
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76. The issues that supervisors are
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holding company, the competent auth
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· A new approval process shall not
Page 27 and 28: · Institutions may not be ready to
Page 29 and 30: 2. Asking institutions to notify su
Page 31 and 32: 116. ‘Immaterial’ should refer
Page 33 and 34: 128. The EU Council has proposed th
Page 35 and 36: should start with inputs, and those
Page 37 and 38: to be only broadly compliant with t
Page 39 and 40: institutions to be able to identify
Page 41 and 42: differentiated if their loss rates
Page 43 and 44: payments are originating from the s
Page 45 and 46: any of its subsidiaries in full, wi
Page 47 and 48: 197. As a general rule, the rating
Page 49 and 50: · Their discounting method results
Page 51 and 52: grades. In this case, all of the re
Page 53 and 54: of challenges, including choosing t
Page 55 and 56: 228. In principle, supervisors do n
Page 57 and 58: prices on defaulted exposures, and
Page 59 and 60: LGD estimation, they have to be tak
Page 61 and 62: The exposure value for the followin
Page 63 and 64: investigating the potential drivers
Page 65 and 66: advisable in some circumstances not
Page 67 and 68: terms) the proof of consistency wit
Page 69 and 70: 302. The information used in credit
Page 71 and 72: exposures to obligors or facilities
Page 73 and 74: Pooled data sets for good predictiv
Page 75 and 76: inputs to the IRB approach. Supervi
Page 77: used to quantify the risk parameter
Page 81 and 82: · Institutions must be able to bri
Page 83 and 84: Benchmarking the outputs of interna
Page 85 and 86: model, and the internal use of the
Page 87 and 88: systems” (Annex VII, Part 4, Para
Page 89 and 90: · Examining reports from Internal
Page 91 and 92: organisational point of view (e.g.,
Page 93 and 94: conclusions are wellfounded. Inte
Page 95 and 96: 401. The role played by the CRC fun
Page 97 and 98: subsidiary, or by different subsidi
Page 99 and 100: way of a formal notification). The
Page 101 and 102: · The rollout plan should have a
Page 103 and 104: Principles and examples 1. The purp
Page 105 and 106: etween systems, recording of data t
Page 107 and 108: · The definition of an appropriate
Page 109 and 110: incorporate forwardlooking elemen
Page 111 and 112: · Approving proactive risk managem
Page 113 and 114: frequency and format of the interna
Page 115 and 116: · Development of internal processe
Page 117 and 118: · Understanding the extent and nat
Page 119 and 120: ‣ If not, inform the other superv
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