CP10 (Full Document) - European Banking Authority

Benchmarking the outputs of internal ratings systems against
external data
341. Benchmarking involves assessing the consistency of the estimated
parameters with those obtained by other estimation techniques (such
as other rating systems), and potentially using other data sources
(such as other institutions or ECAIs). It helps to assess whether
institutions have quantified the risk parameters accurately by
comparing them with a set of ‘reference data’ consisting of
alternative PD, LGD and CF estimates from internal and external
sources.
342. When performing benchmarking risk estimates against other
sources, institutions are expected to investigate the sources of
substantial discrepancies between the values of risk parameters
resulting from their internal risk rating system and those obtained
from the other sources.
343. Regardless of the benchmarking method used, institutions shall
demonstrate to supervisors that their rating systems are performing
in compliance with the minimum requirements in Annex VII, Part 4.
344. At a minimum, the assessment of benchmarking results should focus
on the five points listed in paragraph 340 of this paper. Specifically,
institutions should consider:
· The underlying rating philosophy used in developing rating
systems (e.g., are PDs derived from point­in­time or through­thecycle
ratings?). Institutions that use different rating systems will
need to take into account any differences in their rating
philosophies when backtesting estimates of risk parameters.
Failing to do so would lead to erroneously assigning differences in
rating philosophies to inaccuracies in reported estimates;
· The procedure for establishing tolerance thresholds for validation,
and the list (at least in broad terms) of the types of possible
responses when thresholds are breached;
· The additional qualitative elements of their implementation of
benchmarking;
· The identification of unanticipated changes over time that might
affect benchmarking results;
· At a minimum, institutions should adopt and document policies
which explain the objectives and logic underlying their
benchmarking exercises.
3.5.3. Low­default portfolios
345. The CRD applies certain conditions to PD estimations (for example,
the institution must estimate long­run, forward­looking expected
default rates for each rating grade, with an appropriate margin of
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