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Counting the cost of risk

Are you ready for the changes and impact IRB2021 modelling will have on your portfolios?

The clock's now ticking down on a two-year European Banking Authority (EBA) deadline for banks and lenders to harmonise their analysis of exposure to risk and losses, while being able to accurately define the likely long-term impact on capital.  Experian regulatory expert Davide Boselli explores.

By the end of 2020, Europe's financial institutions will be obliged to be compliant with the EBA's new Internal Ratings Based risk model - IRB2021. While it may seem like yet another post-downturn regulatory hurdle coming hot on the heels of the recent IFRS9 regulations and the slew of Basel guidelines, the EBA is keen to ensure all institutions across Europe are consistent in their approaches to accurately modelling risk analysis.

The EBA says the IRB 2021 approach simply aims to restore trust in internal models by reducing any variability and ensuring the basis of risk estimates across all institutions is done a broadly comparable way. Ultimately, it’s keen to ensure there’s accurate understanding of the impact on any longer-term capital requirements should there be another downturn.

Banks and lenders are expected to fall in line with the guidelines by the start of January 2021. At this point it is expected they will be in a position to consistently define the way their estimation of risk on lending portfolios is analysed for non-defaulted exposures, along with an accurate analysis of the likelihood of default by any higher-risk customers.

Institutions are expected to be able to accurately show they can estimate the level of exposure and allow for any likely losses following defaults, along with the sums that may be recovered following any appropriate remedial action.

Unsurprisingly, recent research showed that regulation and compliance were an on-going concern for more than one in four (27%) CEOs across Europe. The findings were also surprisingly consistent, regardless of industry, sector or region.

IRB 2021 compliance broadly hinges on being able to precisely understand, define and calibrate internal risk models - given they're the basis for the calculation of capital requirements - and ensure they’re laid out in a clear and objective a manner as possible to satisfy the regulator. But it's also accepted no two banks are the same in Europe. As a result, the IRB21 guidelines are sufficiently flexible to allow for the development of risk modelling which ensures subtle differentiation, variance, stress-testing and sensitivity between the quality of banks' differing portfolios.

The goal is to ensure all lenders are in position to show that they have accurately and consistently analysed their risk, exposure to loss and made adequate provision within their capital to cover them.

While the regulations may seem like a burden and far more strict than before, it's accepted that changes to the way loss forecasting is made will create a level playing field to be applied consistently across all of Europe's financial institutions.

Despite the IRB21 deadline being just over two years away, early implementation is being encouraged by regulators. Right now, all institutions are being urged to ensure compliance as soon as possible, and where necessary, define any appropriate implementation plans and timelines for any changes to internal risk modelling.

This is where companies like Experian, specialising in global risk analysis, can help you get your modelling in shape and suitably stress-tested for any downturn.

RiskMinds International

About the author 

Davide has more than 15 years of experience in risk management in the areas of credit risk modelling, rating system validation, regulatory compliance documentation, IT architecture to support the internal rating system and regulatory advisory and credit processes. Before joining Experian he was Chief Risk Officer in Banca Carim. He has also worked in Unicredit's risk governance unit and taken part in a key project to standardise the development of risk model methodology. In addition, Davide has also served as an advisory senior manager at several consultancy firms - including Prometeia and CRIF - and led relevant international projects focused on risk and regulatory areas.

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