Is there a definition of “internal business purposes” and a list of activities which are considered eligible for internal business purposes in Annex I, Part II, Section 2, paragraph 6 of Regulation (EU) No 529/2014 - RTS on materiality of extensions and changes in the advanced approaches (IRB and AMA)? Are there any impediments to the usage of re-developed IRB models for managerial/internal business purposes?
Background
In line with the Article 5 of Delegated Regulation 529/2014, “Changes to the IRB approach not considered material“; point 1 (a)(ii), those changes, which are described in Annex I, Part II, Section 2, shall be notified to competent authorities at least two months before their implementation. In paragraph 6, Annex I, Part II, Section 2, "Changes in the use of models, if an institution starts using risk parameter estimates for internal business purposes that are not those used for regulatory purpose and, where this was previously not the case, within the lines set out according to Article 179(1) of Regulation (EU) No 575/2013". Due to a lengthy approval process of IRB models a bank intends, in line with Paragraph 6, Annex I, Part II, Section 2 of RTS 529/2014, to start using the re-developed/recalibrated IRB model for managerial/internal business purposes (namely underwriting of mortgages, risk margin calculation, i.e. risk based pricing, expected loss calculation for performing loans /provision estimates). For RWA and capital calculation the bank will be using the current model (which have a prior approval by competent authority). Is there a definition of internal business purposes and a list of activities which are considered eligible for internal business purposes? Are there any impediments to be considered before the bank proceeds with the above mentioned intention?
Answer
According to Annex I, Part II, Section 2, paragraph 6 of Regulation (EU) No 529/2014 “changes in the use of models, if an institution starts using risk parameter estimates for internal business purposes that are not those used for regulatory purpose and, where this was previously not the case, within the lines set out according to Article 179(1) of Regulation (EU) No 575/2013 (CRR)” require ex ante notification to competent authorities. A possible scenario of usage of re-developed IRB models for internal business purposes could be that of changes in terms of Article 143 CRR that have not been approved so far by the Component Authority. Indeed Article 144 CRR, specifies the standards that shall be demonstrated as met to the satisfaction of the competent authorities for an institution being permitted to use the IRB Approach , including under point (b) that “internal ratings and default and loss estimates used in the calculation of own funds requirements and associated systems and processes play an essential role in the risk management and decision-making process, and in the credit approval, internal capital allocation and corporate governance functions of the institution”. Thus, the term “internal business purposes” used in Annex I, Part II, Section 2, Paragraph 6 of Regulation (EU) No 529/2014 should be read together with Article 144(1)(b) CRR. In the same sense, Article 76 of Directive (EU) No 36/2013 (CRD) refers to the processes associated with the involvement of the management body in the taking up, managing, monitoring and mitigating the credit risks of the institution. In this context see also Commission Delegated Regulation (EU) 2022/439 - RTS on the specification of the assessment methodology or the specification of the assessment methodology competent authorities are to follow when assessing the compliance of credit institutions and investment firms with the requirements to use the Internal Ratings Based Approach , including the assessment of use test in risk management, decision making and credit approval process, internal capital allocation and corporate governance functions.
Original source: European Banking Authority, Q&A ID 2016_2983
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