28 July 2022
The European Banking Authority (EBA) launched today a consultation on its supervisory handbook for the validation of internal ratings based systems. This handbook clarifies the role of the validation function as part of corporate governance, in particular in terms of scope of work and interaction with the credit risk control unit. The consultation runs until 28 October 2022.
This handbook provides some general guidance on the expectations relative to the validation function, as already laid out in Article 185 of the Capital Requirements Regulation (CRR). It builds on the EBA regulatory technical standards (RTS) and guidelines which are part of the ‘IRB repair roadmap’, and provides a detailed description of the areas which the validation function is expected to assess.
In practice, the handbook does not present any specific methodology to be used by the validation function. Instead, the handbook specifies which elements of institutions’ rating systems are expected to be assessed by the validation function. As such, it covers both the tasks related to the pure model performance assessment, mirroring the CRR distinction between risk differentiation and risk quantification, as well as the tasks dealing with the modelling environment, such as data quality and model implementation assessment. While describing the specificities of the validation function tasks, the handbook clarifies its relationship with other functions related to the corporate governance, such as the credit risk control unit and the internal audit.
In addition, the handbook provides a set of expectations and good practices on the work of the validation function depending on its position in the model cycle (i.e. first or subsequent validation), as well as some additional guidance for the validation of rating systems when using external data, when outsourcing some validation tasks, as well as in a situation of data scarcity.
Responses to this consultation can be sent to the EBA by clicking on the “send your comments” button on the consultation page. Please note that the deadline for the submission of comments is 28 October 2022.
A public hearing will take place via conference call on 4 October 2022 from 14:00 to 16:00 CEST. The deadline for registration is the 3 October 2022, 18:00 CEST.
All contributions received will be published after the consultation closes, unless requested otherwise.
Legal basis and next steps
The task of the EBA to develop and maintain a supervisory handbook stems from Article 8(1)(aa) of the Regulation (EU) No 1093/2010 (the ‘EBA Regulation’). The supervisory handbook should cover all matters which are within the EBA’s remit with the aim to set out best supervisory practices rather than provide further specifications for the application of the legislation.
The supervisory handbook, just like the EBA Guidelines, is non-binding nature, of general application and acts of Union law whose validity can be determined only by the Union courts in a preliminary ruling. However, unlike guidelines, the supervisory handbook is not addressed directly to financial institutions but to competent authorities, and does not limit their judgment-led supervision. As no ‘comply or explain’ mechanism is applicable to the handbook, any departure from it can be justified merely on the needs of judgment-led supervision.