Application of risk parameters
In the application of the PD or LGD model and where institutions receive new information with respect to a relevant risk driver or rating criterion, they should take this information into account in the rating assignment in a timely manner, in particular by ensuring both of the following:
that the relevant IT systems are updated as soon as possible and that the corresponding rating and PD or LGD assignment is reviewed as soon as possible;
where the new information relates to the default of an obligor, that the PD of the obligor is set to 1 in all relevant IT systems in a timely manner and in accordance with paragraph 108 of the Guidelines on the application of the definition of default under Article 178 of Regulation (EU) No 575/2013.
8.1Conservatism in the application of risk parameters
For the purpose of Article 171(2) of Regulation (EU) No 575/2013 institutions should apply additional conservatism to the outcomes of the rating assignment where any deficiencies are identified related to the implementation of the model in the IT system or to the process of assignment of risk parameters to obligors or facilities in the current portfolio (application of risk parameters), especially when those deficiencies relate to data used in the rating assignment process. They should do so by establishing a framework that consists of the following phases:
identification of deficiencies of implementation of the model in the IT system or application of risk parameters;
specification of the form of conservatism to be applied and quantification of the appropriate level of conservatism;
monitoring of the deficiencies and correcting them;
documentation.
For the purpose of paragraph 195(a) institutions should have a robust process for identifying all implementation and application deficiencies in the assignment process, whereby each deficiency leads to additional conservative treatment in the affected assignment to a grade or pool. Institutions should consider at least the following triggers for additional conservatism:
missing data in the application portfolio;
missing updates of financial statements or credit bureau data as referred to in paragraph 59(h);
outdated ratings in the application portfolio; where outdated rating should be understood as specified in Article 25(2)(b) of the RTS on IRB methodology;
missing ratings, whereby an exposure is considered as being within the scope of application of the IRB model but is not rated by it.
For the purpose of paragraph 195(b) institutions should ensure that the occurrence of any of the triggers referred to in paragraph 196 results in the application of additional conservatism to the risk parameter for the purpose of the calculation of risk-weighted exposure amounts. Where more than one trigger occurs, the estimate should be more conservative. The additional conservatism related to each trigger should be proportionate to the uncertainty in the estimated risk parameter introduced by the trigger.
Institutions should consider the overall impact of the identified deficiencies and the resulting conservatism at the level of portfolio covered with the relevant model on the soundness of the assignments to grades or pools and ensure that the own funds requirements are not distorted by the necessity of excessive adjustments.
For the purpose of paragraph 195(c) institutions should regularly monitor the implementation and application deficiencies and the levels of additional conservatism applied in relation to them. Whenever possible, institutions should take steps to address the identified deficiencies. Following its assessment, the institution should develop a plan to rectify the deficiencies within a reasonable timeframe, taking into consideration the magnitude of the impact on the own funds requirements.
For the purpose of paragraph 195(d) institutions should specify adequate manuals and procedure for applying additional conservatism and should document the process applied in addressing implementation and application deficiencies. Such documentation should contain at least the triggers considered and the effects that the activation of such triggers had on the final assignment to a grade or pool, the level of risk parameter and on the own funds requirements.
8.2Human judgement in the application of risk parameters
Institutions may use human judgement in the application of the model in the following cases:
Institutions should specify clear criteria for the use of qualitative model inputs and they should ensure a consistent application of such inputs by all relevant personnel and a consistent assignment of obligors or facilities posing similar risk to the same grade or pool as required by Article 171(1)(a) of Regulation (EU) No 575/2013.
For the purpose of Article 172(3) of Regulation (EU) No 575/2013 institutions should specify the policies and criteria for the use of overrides in the rating assignment process. These policies should refer both to possible overrides of inputs and outputs of such process and should be specified in a conservative manner such that the scale of conservative overrides should not be limited. In contrast, the scale of potential decreases of the estimates resulting from the model, either by overriding the inputs or outputs of the rating assignment process, should be limited. In applying the overrides institutions should take into account all relevant and up-to-date information.
Institutions should document the scale and rationale of each override. Wherever possible institutions should specify a predefined list of possible justifications of the overrides to choose from. Institutions should also store information on the date of override and the person that performed and approved it.
Institutions should regularly monitor the level and justifications for overrides of inputs and outputs of the rating assignment process. They should specify in their policies the maximum acceptable rate of overrides for each model. Where those maximum levels are breached, adequate measures should be taken by the institution. The rates of overrides should be specified and monitored at the level of calibration segment. Where there is a high number of overrides institutions should adopt adequate measures to improve the model.
Institutions should regularly analyse the performance of exposures in relation to which an override of input or output of the rating assignment process has been performed in accordance with Article 172(3) of Regulation (EU) No 575/2013.
Institutions should regularly assess the performance of the model before and after the overrides of outputs of the rating assignment process. Where the assessment concludes that the use of overrides significantly decreased the model’s capacity to accurately quantify the risk parameters (‘predictive power of the model’), institutions should adopt adequate measures to ensure the correct application of overrides.
8.3Use of internal ratings and default and loss estimates
In accordance with Article 144(1)(b) of Regulation (EU) No 575/2013 and Articles 18 to 21 of the RTS on IRB assessment methodology institutions should use the same estimates of risk parameters for the purpose of own funds requirements calculation and for internal purposes, including risk management and decision-making processes, unless all of the following conditions are met:
the deviation is justified and appropriate for the specific area of use;
the deviation does not lead to a change in rank ordering in the assignment of obligors or facilities to grades and pools within a calibration segment other than within each grade or pool;
the deviation is due to the use of parameters for internal purposes without consideration of the MoC, without regulatory floors, without downturn adjustment in the case of LGD estimates or is due to the use of a different calibration method, which may entail specifying different calibration segments.
For the purpose of paragraph 208 it may also be considered adequate to group continuous risk parameter estimates into homogenous ranks for internal purposes.
Where institutions use for internal purposes estimates of risk parameters that are different from those used in the calculation of own funds requirements they should periodically reflect this in their internal reporting to senior management by providing information on both sets of parameters. In any case internal reporting should include all elements specified in Article 189(3) of Regulation (EU) No 575/2013 based on the estimates of risk parameters used for the purpose of calculation of own funds requirements.
8.4Calculation of IRB shortfall or excess
For the purpose of this chapter the difference between, on the one hand, general and specific credit risk adjustments, additional value adjustments and other own funds reductions relating to these exposures and, on the other hand, expected loss amount in accordance with Article 159 of Regulation (EU) No 575/2013 should be considered IRB shortfall, if negative, and IRB excess, if positive.
Where the calculation for the overall non-defaulted portfolio referred to in Article 159 of Regulation (EU) No 575/2013 results in an IRB excess, institutions may use this IRB excess to cover for any IRB shortfall from the calculation carried out in accordance with that Article for the overall defaulted portfolio.
For the purposes of adding any IRB excess to Tier 2 in accordance with Article 62 (d) of Regulation (EU) No 575/2013, where the calculation referred to in Article 159 of Regulation (EU) No 575/2013 results in an IRB excess for both the defaulted and the non-defaulted portfolio, the sum of those two IRB excesses should be considered and added to Tier 2 in accordance with the limit referred to in Article 62(d) of Regulation (EU) No 575/2013.
For the purposes of Article 159 of Regulation (EU) No 575/2013 institutions should not include partial write-offs in the calculation of general and specific credit risk adjustments. However, as per Article 166(1) of Regulation (EU) No 575/2013, the calculation of the expected loss amount for the application of Articles 158 and 159 of Regulation (EU) No 575/2013 should be based on the exposure value gross of value adjustments but net of write-offs.