Deloitte Banking Alert: EBA and ECB progress towards harmonized supervision

Significant progress has been made by the European Banking Authority (EBA) and the European Central Bank (ECB) towards attaining harmonised supervision, according to Deloitte.

I) EBA publishes progress report on the implementation of IRB roadmap (9th July 2019)

The roadmap was set out by EBA in February 2016. Its objective was to mitigate the undue variability in the application of internal models. Final goal being to ensure comparability of the estimates of risk parameters without reducing their risk sensitivity.

Recognising the concerns of both the industry and national regulators, the EBA has decided to extend certain implementation timelines associated with this work, namely:

. The deadline for introducing changes in the ratings systems, which has been extended by one year to the end-2021.

. The deadline for implementation of changes in the loss given default (LGD) and conversion factors models for low default portfolios, which has been extended until end-2023 at the latest.

The report also considers the interaction of the IRB roadmap with the December 2017 Basel framework (i.e. “Basel 4”). It reiterates that the two sources of revisions are to be considered complementary, and taken together. The EBA considers that the Basel revisions are based on top-down repair measures, while the EBA roadmap seeks to address undue variability of RWAs from the bottom up.

The EBA urges that institutions continue the implementation of the bottom-up reforms in the IRB roadmap at the current pace, as, in their view, those revisions can be implemented independently of the Basel reforms. Besides the Guidelines on credit risk mitigation which are currently under consultation, the EBA does not plan to make any further revisions to its guidance on internal models.

Its focus will now be on measuring the effectiveness of the revisions, as well as working to improve transparency through harmonised Pillar 3 disclosures, based on the revised requirements under CRR2.

The EBA believes that the implementation of the its bottom-up repair alongside the topdown reforms set out in the final Basel III framework will significantly reduce undue variability of own funds requirements. It is, therefore, important that the implementation efforts continue at the current high pace, ensuring continued credibility of the IRB framework.

II) ECB finalizes guide to harmonize rules on banks’ internal models (8th July 2019)

The European Central Bank (ECB) published the final chapters of its guide to internal models, following a public consultation which ended on 7 November 2018. The guide must help in defining a general framework to be applied for attaining a consistency in methods used for own funds requirement calculation.

The three risk type-specific chapters cover credit risk, market risk and counterparty credit risk. They are intended to ensure a common and consistent approach to the most relevant aspects of the regulations on internal models for banks directly supervised by the ECB. This follows the publication of the general topics guide (i.e. not risk type-specific) in November 2018.

The risk type-specific chapters provide transparency on how the ECB understands the regulations on the use of internal models to calculate own funds requirements for credit risk, market risk and counterparty credit risk.

The guide was drafted in close cooperation with the national competent authorities and draws on the experience gained in the context of the targeted review of internal models (TRIM) project. Before the public consultations were launched, banks provided feedback and, as part of the TRIM project, reviews and horizontal analyses were conducted. TRIM is a multi-year project which aims to make the implementation of internal models more consistent. It is essential to creating a level playing field for banks under ECB supervision.

III) EBA IRB roadmap and ECB guide go hand in hand

Increasing pressure from both institutions with regard to implementation of more reliable risk models that need to assure comparability between themselves and deliver desired results that are anchored to micro and macroeconomic specificity of the portfolios they work whit. A proactive attitude of the financial institutions, auditors and competent authorities will be instrumental in order to deal with the regulatory changes envisioned by EBA and ECB.