In February 2017, the European Central Bank (ECB) published the first version of its Guide for the Targeted Review of Internal Models, or TRIM Guide. This guide sets out the ECB's view on the supervisory practices it considers appropriate and explains its interpretation of the European Union’s regulatory framework in relation to internal models and general aspects of model governance. A consolidated version of this guide was subsequently published in October 2019.
Consultation on revised Guide to internal models
The European Central Bank's revised Internal Model Guidance, currently under consultation, incorporates the supervisor's interpretation of the most recent updates to the legal framework. On the one hand, it addresses how banks should include climate and environmental risks in their models. It also provides clarification for banks wishing to revert to the standardised approach for calculating their risk-weighted assets. With specific regard to credit risk, the ECB includes the definition of default and a consistent treatment of mass write-offs. It also incorporates nuances on internal market and counterparty models.
This Technical Note aims to summarise the highlights of the revised internal models guidance:
- In the general aspects chapter as a new feature, the revised Guidance includes two new sections covering general principles on climate and environmental risks as well as the use of a modified or extended model.
- For credit risk, the Guidance clarifies the ECB's expectations on a number of aspects related to internal models used under the IRB approach. In addition, this version contains a new section on the definition of default, including the ECB's interpretation of the relevant provisions to ensure a common and consistent approach to their application. The section on probability of default has also been revised with a focus on calibration to provide more detail on the ECB's supervisory expectations regarding additional calibration tests.
- In the chapter on market risk, the Guidance clarifies the ECB's expectations on a number of aspects related to internal models used in the calculation of own funds requirements for market risk. In addition, more detail has been included with regard to trading book delineation and rating validation requirements, probability of default and recovery rate assumptions.
- Finally, the chapter on counterparty risk, which seeks to clarify the ECB's expectations on a number of aspects related to the principles defined in the Internal Models Approach, provides more detail on the margin periods of risk and adds two new sections on use testing and on risks not included in the Effective expected positive exposure.
Download the technical note on Consultation on revised Guide to internal models.