EBF response to the EBA discussion paper on the future of the Internal Rating Based (IRB) approach

01 May 2015

The European Banking Federation (EBF) has conducted an in-depth study on the characteristics of IRB models. The upshot of the study was that model differences stem from 3 sources, namely market characteristics, supervisory practices and bank modelling choices.

Other works produced in the last  3  years  by  the  industry  and  by  the  public  sector  confirm  the  existence  of  legitimate differences  and  other  differences  that  are  inherent  to  the  market  or  business  and  other differences that could be narrowed for the sake of easier comparability.

The EBF is therefore committed to improve the functioning and the image of IRB models as the most  accurate  tool  to  calculate  regulatory  capital  requirements  commensurate  to  the  risk involved.  In this  endeavour,  the  EBA,  as  well  as  other  policy making  institutions,  should  take into account the cost and timing of the policy measures in order to prioritise those that can achieve further improvement at a lower cost. Nevertheless, a fundamental review of the IRB approach that is related to model options should be done in close coordination with the Basel Committee at a global level.

The action plan that will follow this discussion paper should take into account the developments that the international policy making community is preparing as regards the use of IRB models, in particular the Basel Committee. EBF believes that European institutions should maintain a firm stance in support of risk sensitive models which, after all, have less disadvantages than other blunter solutions like the leverage ratio and capital floors.

EBF agrees that a more prescriptive approach for the conceptualisation and implementation of the different technical components of IRB is, without doubt, a contribution for the mitigation of  the  current  discretion  in  the  calculation  of capital  requirements  under  IRB.  Although  EBF recognises the completeness of the EBA diagnosis under this discussion paper EBF alerts that, not always, previous guidelines or RTS have been sufficient objective and prescriptive to fulfil this ambitious goal.

EBF appreciates EBA acknowledgment that the IRB framework has proven its validity as a risk sensitive way of measuring capital requirements and intends to encourage the institutions to implement  sound  internal  risk  management  practices  and  EBF  supports  EBAs work  to  analyse measures that could strengthen the trust in internal models. EBF considers it important that IRB continues to be a driver to strengthen banks risk management practices. There must be a right balance between risk sensitivity and simplification. Too high a degree of simplification and conformity  in  parameters  and  models could lead  to  herd  behaviour  which  may  increase  the vulnerability of the whole financial system.

EBF considers that some of the observed variation is due to banks different risk profiles. This has to be accounted for as EBA considers further harmonisation of practices. Some of these items could be elaborated on in separate consultations to be able to thoroughly analyse and convey well considered input and consequences. EBA should firstly analyse and harmonise the definitions, e.g. definition of default, before model options and other conceptually important drivers of risks are changed.

As the default rules have been applied differently in Europe, changing the rules will have bigger impact to banks that have implemented the 180 days option, thus a common transition period should be allowed for those countries that have to adjust to a new definition. Other important factors  that  could  be  harmonised  are a  coordinated  implementation  but  also  common transitional  rules  in  a  future  regulation. Additional national transitions rules do not support transparency and single rule book.

Just as important as new regulations, is the removal of old supervisory practices, harmonisation of discretionary add-ons and other measures, which should be subject to a continued follow-up by EBA. EBF has learned that it is a challenge, for cross border groups to adjust to national supervisory practices, which also may deviate from the single rule book.

In order  to  avoid  a  wider  range  of  supervisory  practices,  EBF  encourages  EBA  to  consider  if guidelines should be replaced by regulatory standards. EBF thinks that guidelines leave too wide leeway for supervisors and that is a source of supervisory differences.

The  EBF  response  reflects  the  expertise  and  views  of  its  member  associations  and  banks.  It includes indications as to the effects that the proposed changes could have in the European banking business and its wider economic environment.

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