EBA assesses EU banks’ internal approach for capital requirement calculations

The European Banking Authority (EBA) today published its 2023 Reports on the annual market and credit risk benchmarking exercises. 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, for the majority of participating banks, the results confirm a relatively low dispersion in the initial market valuation (IMVs) of most of the instruments, and a decrease in the dispersion in the value at risk (VaR) submissions compared to the previous exercise. For credit risk, the variability of RWAs remained stable compared with the previous year, but for some asset classes a reduction could be observed in a longer perspective.

Market Risk exercise

The Report presents the results of the 2023 supervisory benchmarking and summarises the conclusions drawn from a hypothetical portfolio exercise (HPE) conducted in 2022/23.

The results confirm that most participating banks have seen a relatively low dispersion in the initial market valuation (IMVs) of most of the instruments, and a decrease in the dispersion in the value at risk (VaR) submissions compared to the previous exercise.

From a risk factor perspective, FX portfolios exhibit a lower level of dispersion than the other asset classes. In general, variability is substantially lower than in the previous exercise. This is likely due to an improvement in the data submission, which impacted the dispersion of the risk measures, decreasing the dispersion in general.

Regarding the single risk measures, across all asset classes except for CO, the overall variability for value at risk (VaR) is lower than the observed variability for stressed VaR (sVaR) (16% and 21%, compared to 21% and 28% in the 2022 exercise, with 27% and 31% in 2021 and with 18% and 29% in 2020). More complex measures, such as the incremental risk charge (IRC), show a higher level of dispersion (42%, compared to 45% in the 2022 exercise, with 43% in 2021 and 49% in 2020).

Competent authorities also complemented a questionnaire on banks participating in the exercise to supplement the quantitative analysis. The majority of the significant dispersions have been examined and justified by the banks and Competent Authorities. A small minority of the outlier observations remain unexplained and are expected to be part of the ongoing activities of supervisors, who are expected to monitor and investigate the situation.

The report shows that the relative share of the Exposure at Default (EAD) subject to the Internal Ratings Based (IRB) method appears 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 (set out by the EBA in February 2016) is progressing.

The report goes on to show the evolution of the variability of the risk parameters over the period 2015-2023. A clear decreasing trend of variability can be observed in the Corporates class, whereas for the other asset classes the variability seems more stable. The report provides evidence 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 portfolio Retail shows the role that the type and degree of collateralisation can play in explaining the variability of the Loss Given Default (LGD).

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.