The governance of credit risk models and the estimation of credit risk parameters (probability of default, loss given default and Expected Loss Best Estimate) are now coming under increasing scrutiny from banking supervisory authorities. In this note, we therefore analyze regulatory requirements in terms of governance and estimation of credit risk parameters.
The rating is mainly based on the EBA guidelines (EBA/GL/2017/16¹ and EBA/GL/2019/03²) and the TRIM (Targeted Review of Internal Models) guide.
These guidelines, which come into force in January 2021, specify the requirements for estimating credit risk parameters. The TRIM guide explains how supervisory authorities interpret European regulations on internal risk measurement models (credit, market and counterparty) and model governance. The TRIM exercise, which ran from 2015 to 2019, aimed to:
- Ensure the credibility of internal models and confirm their suitability for calculating regulatory capital;
- Ensure regulatory compliance of models and reduce RWA (Risk-Weighted Assets) variability due to inappropriate modeling.
The aim of this note is to analyze the regulatory requirements on credit risk to show the fundamental modeling points to which supervisors are now paying close attention.
¹ EBA Consultation paper on Guidelines on PD estimation LGD estimation and the treatment of defaulted exposures, 14 November 2016.
² EBA Guidelines for the estimation of LGD appropriate for an economic downturn ('Downturn LGD estimation'), March 6, 2019.
