Minimum requirements for the use of rating systems

Factsheet

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Question:

Does DNB always immediately withdraw permission for the use of the internal ratings-based approach (IRB) if the financial undertaking no longer complies with the minimum requirements for the use of rating systems?

Published: 14 July 2009

Answer:

DNB has the power to withdraw permission for the use of the IRB approach. If the financial undertaking no longer complies with the minimum requirements for the use of rating systems, both it and DNB will generally consider whether the model can be adjusted.

Section 3.6 of the Supervisory Regulation on Solvency Requirements for Credit Risk provides that a model must have adequate predictive power. The explanatory note to Article 3:88 states that the model validation process must in part focus on the degree of objectivity and conservatism used in the rating systems. The ultimate aim is objectivity in the form of adequate predictive power.

If the model does not comply with Part 10.2 of the Besluit prudentële regels Wft [Decree on Prudential Rules for Financial Undertakings], the financial undertaking is, in principle, obliged under Section 69 (7) of said Decree to submit a plan to satisfy the IRB requirements again as soon as possible. Where this aim of re-compliance is (temporarily) not realised, corrections may be made by means of conservatism. If, for example, it is found that the model is underestimating risk, it will not be possible in all cases to improve the model immediately. Strictly speaking, the financial undertaking would then no longer have a validated model. By adding a certain margin of conservatism to the risk parameters, this situation can be temporarily corrected. The financial undertaking is expected to make every effort to improve the model.

Adjustment of parameters

Until such time as it has carried out this improvement, however, it must factor an extra measure of conservatism into its risk estimates. DNB may issue a direction to this effect if necessary. DNB would prefer the financial undertaking to include the conservatism in the risk parameter (PD, LGD or CCF/EAD) which is not being properly estimated, but for reporting purposes and the calculation of the solvency ratio, it may agree that the amount that would result from this adjustment be temporarily incorporated straight into ID 2.1.2. of the Capital Adequacy (CA) template in COREP.

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