The EBA publishes its annual assessment of banks’ internal approaches for the calculation of capital requirements

The European Banking Authority (EBA) today published its 2024 Reports on the annual market and credit risk benchmarking exercises. For the first time, the EBA also released a specific Report on the fundamental review of the trading book Alternative Standardised Approach (FRTB ASA). These exercises aim at monitoring the consistency of risk weighted assets (RWAs) across all EU institutions authorised to use internal approaches for the calculation of capital requirements.

Regarding market risk, the decline in the dispersion in the various risk measure is confirmed for this exercise. For credit risk, the variability of RWAs remained stable compared to the previous year, but for some asset classes a reduction could be observed in the longer run for some asset classes and parameters.

Market Risk

The Market Risk Benchmarking IMA Report presents the results of the 2024 supervisory benchmarking and summarises the conclusions drawn from a hypothetical portfolio exercise (HPE) conducted in 2023/24.

The results confirm that most participating banks have seen a relatively low dispersion in the initial market valuation (IMVs), though slightly higher compared to 2023. However, a decline in the dispersion in risk measures submissions was noticed compared to the previous exercise.

In general, variability has declined constantly through past exercises. This is likely due to better data submissions by the participating banks, as a result of improved instructions, knowledge of the portfolios and the resolution of issues encountered in the previous exercise.

Regarding the single risk measures, the overall variability for value at risk (VaR) is lower than the observed variability for stressed VaR (sVaR) (14% and 21%, compared to 16% and 21% in 2023, and to 21% and 28% in the 2022 exercise). More complex measures, such as the incremental risk charge (IRC), show a higher level of dispersion (44%, it was 42% in 2023 exercise, 45% in the 2022).

The assessment by competent authorities of the over- and underestimation of RWAs was encouraging as the latter were aware of and able to explain the causes of almost all deviations. While most of the causes were identified and actions put in place in order to reduce the unwanted variability of RWAs, the effectiveness of these actions can be evaluated only by competent authorities via constant monitoring of the benchmarking results.

The benchmarking on the FRTB ASA will become even more critical in the future, as it will be extended to banks that apply the ASA methodology independently without the current requirement of having been granted permission to adopt internal models for market risk's own funds requirements. One positive aspect of the ASA data collection is that the Own Funds Requirements (OFR) computed using this methodology is already significantly more consistent than the IMA methodology. On the other side, the Default Risk Charge (DRC), residual risk add-on (RRAO) and the validation portfolios highlighted some inconsistencies in the data submissions.

Credit Risk exercise

The relative share of the Exposure at Default (EAD) subject to the Internal Ratings Based (IRB) method appears slightly decreasing in the medium run but practically constant in the last years.

Furthermore, the share of approved material model changes has increased for all asset classes, indicating that the implementation of the IRB roadmap is progressing.

The Report shows a clear decreasing trend of variability, measured in terms of standard deviation, can be observed for the PD while for the LGD it more difficult to observe a clear trend. The Report also proves that, besides risk factors able to capture the underlying portfolio characteristics, prudential adjustments could potentially explain part of the variability.

A specific analysis regarding the Retail portfolio shows the role that the type and degree of collateralisation can play in explaining the variability of the Loss Given Default (LGD). 

Notes to the editors

These annual benchmarking exercises contribute to improving the regulatory framework, increasing convergence of supervisory practices and, thus, restoring confidence in internal models. For credit risk internal models, the EBA has followed its roadmap for the implementation of the regulatory review of internal models.

This exercise should be read in parallel with other efforts to reduce undue level of variability. In particular, the  EBA roadmap to Repair IRB models is a key component of the review of the IRB framework, along with the enhancements brought by the final Basel III framework assessed by the EBA in a set of recommendations as an answer to the call for advice of the European Commission.

The exercises provide a regular supervisory tool based on benchmarks to support competent authorities' assessments of internal models and produce comparisons with EU peers.