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>> Credit Risk

>> Interest Rate Risk in the Banking Book (IRRBB)

>> IRB models

​>> Capital Floors​

Updated: January 2017

Credit Risk



Generally speaking, ESBG believes that the Basel Committee's second proposal is a notable improvement to the first one. For instance, we appreciate the re-introduction of external ratings as a factor determining the risk weight of exposures. However, ESBG continues to have serious doubts that the proposed framework would be able to improve comparability and remove unjustified differences in risk weights. Furthermore the proposed framework seems too prescriptive and simplified to serve as a reference point for risk weight floors and/or when evaluating the risk weights of internationally active IRB-banks. Apart from this, ESBG considers that the risk weight for SMEs could be a little bit lower, both regarding the corporate and retail exposures classes. Otherwise, the combined effect of higher RWAs and higher capital requirements could significantly reduce the credit availability for SMEs. Finally, ESBG believes that the loan to value ratio (LTV) for residential real estate exposures should be calculated using updated property valuations in jurisdictions where such value updates are possible.


The Basel Committee Task Force on Standardised Approaches (TFSA) issued on 22 December 2014 a first consultative document on revision of the framework on credit risk for the standardised approach. A second consultation paper was published on 10 December 2015. The Committee's intention is to review the existing capital framework to balance simplicity and risk sensitivity, and to promote comparability by reducing variability in risk-weighted assets across banks and jurisdictions. The revision of the standardised approach will also have an impact on the IRB models, since it is proposed that the standardised approach risk weights will serve as a reference point for risk weight floors imposed on IRB banks.

Apart from the second consultation paper, another comprehensive quantitative impact study (QIS) was carried out. Generally speaking, the Basel Committee envisages finalising the revised standard soon.​

Interest Rate Risk in the Banking Book (IRRBB)



ESBG has been emphasising that both approaches proposed (Pillar 1 and Pillar 2) are too standardised, and therefore not appropriate for reflecting the actual level of interest rate risk in a banking institution. Furthermore, the suggested Pillar 1 approach might even endanger the bank’s ability to continue providing low-risk savings products to customers at their current levels. Instead of introducing a highly-standardised, one-size-fits-all approach, ESBG advocates for improving the current framework by using a common set of basic principles that would still allow for different methodological approaches.


On 8 June 2015, the Basel Committee issued a consultative document on the risk management, capital treatment and supervision of the interest rate risk in the banking book (IRRBB). The Committee's review of the regulatory treatment of the IRRBB is motivated by two objectives: First, to help ensure that banks have appropriate capital to cover potential losses from exposures to changes in interest rates. This is particularly important in the light of the current exceptionally low-interest rate environment in many jurisdictions. Second, to limit capital arbitrage between the trading book and the banking book, as well as between banking book portfolios that are subject to different accounting treatments. On 22 May 2015, the EBA presented updated guidelines on the interest rate risk arising from non-trading activities.

The updated EBA guidelines have been applicable since 1 January 2016. Moreover, the EBA stated that these guidelines may be modified to contemplate the recent revisions by the Basel Committee.​


Internal Ratings-Based (IRB) Models



ESBG supports the EBA's initiatives aiming at enhancing the trust in IRB models as a valid tool to measure capital requirements. It seems appropriate and necessary to establish common methodologies for IRB models, which aim to guarantee a level playing field. However, the margin of conservatism must not be considered as a separate measure to achieve a general increase of own funds. The margin of conservatism should be related to weaknesses in the models. The design of the models must be respected, and should not be subject to add-ons based on unquantifiable supervisory judgments. Furthermore, there should not be an increase of administrative burdens for institutions.


​On 4 March 2015 the EBA launched a discussion paper on regulatory measures to review internal ratings based (IRB) models. The EBA intended to identify the main regulatory actions necessary to address the key drivers of variability in the implementation of IRB models. On 4 February 2016 the EBA published an opinion specifying the general principles and timelines for the implementation of the regulatory review of the IRB approach. The EBA reiterates its stance in favour of the continued use of the IRB approach. The changes to the regulatory framework proposed by the EBA aim at addressing the current concern about the lack of comparability of capital requirements determined under the IRB approach across institutions. Furthermore, the European Central Bank (ECB) recently launched a project reviewing internal models (called "TRIM": Targeted Review of Internal Models) in order to restore the credibility, adequacy and appropriateness of approved Pillar 1 internal models used by significant institutions in the Single Supervisory Mechanism (SSM). Moreover, very importantly, on 24 March 2016, the BCBS released a consultative document entitled "Reducing variation in credit risk-weighted assets – constraints on the use of internal model approaches". It sets out a proposed set of changes to the Basel framework's advanced internal ratings-based approach (A-IRB) and the foundation internal ratings-based approach (F-IRB).

​According to the EBA, all changes related to the regulatory review of the IRB approach should be finalised by the end of 2020, at the latest. TRIM is expected to make recommendations to institutions and publish supervisory guidelines which shall ensure that internal models give consistent results across banking institutions. TRIM is moreover expected to verify at the end of the day whether risks are modelled correctly and hence capital needs are calculated adequately. The TRIM project is envisaged to last for three years. It is, however, possible that it continues after 2018. Apart from this, the changes that the Basel Committee recently proposed to the IRB approaches are a key element of the regulatory reform programme that the Committee has committed to finalise by end-2016.

Capital Floors


ESBG replied on 27 March 2015 to the consultation. ESBG  emphasised the importance of continuing to allow banks to use internal models as they provide a more risk-sensitive result when calibrating risks. We are concerned that the introduction of new, binding capital floors could reduce risk sensitivity. Indeed, we believe that the Basel Committee should be careful when aiming to "enhance the comparability of the capital outcomes across banks" through new capital floors. We have doubts whether such floors are able to be sufficiently sensitive to the specific risk profiles of different institutions and the specificities of the various national jurisdictions. 

It is therefore doubtful whether the results would actually make capital outcomes more comparable vs. making them more similar, while actually masking the real underlying differences in risk profiles. Diversity of the models is also desirable from a banking supervision point of view as it will reduce the systemic risk that otherwise could occur if all banks are affected simultaneously by the same measurement error, because they use similar models.

Moreover, ESBG recommended Basel Committee should not overlook the close links with the existing prudential framework, in particular Basel III, which already contains a backstop on capital through the leverage ratio. 


At the end of 2014, the Basel Committee published a consultative paper on the design of a capital floor framework based on standardised, non-internal modelled approaches. The floor proposed by the Basel Committee aims to ensure that the level of capital across the banking system would not fall below a certain level. The floor is also intended to mitigate model risk and measurement error stemming from internally-modelled approaches. Furthermore, it should enhance the comparability of capital outcomes across banks and complement the leverage ratio, which was introduced as part of Basel III.