EBA · 2023_6798 Final Q&A

Use of the last available data for risk quantification sample

Regulation
Regulation (EU) No 575/2013 (CRR)
Article
179, para. 1
Topic
Credit risk
Submitted by
Credit institution
Submitted
2023-05-10
Answered
2024-02-02
Answer provided by
ESAs (EBA, ESMA, EIOPA)
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Question

Given the requirements of Articles 179(1)(a) and 175(4)(b) CRR, in case of a model development, should the last available one-year snapshot be used for risk quantification purposes (i.e., for the computation of the long-run average default rate) or be set aside for out-of-time validation tests?

Background

Article 179(1)(a) CRR requires that “ an institution's own estimates of the risk parameters PD, LGD, conversion factor and EL shall incorporate all relevant data, information and methods ”, on the other hand Article 175(4)(b) CRR requires out-of-time and out-of-sample performance tests for validating the model. While in the risk differentiation phase the presence of an out-of-time validation sample can be guaranteed, in the context of initial validation, it is not clear if the last available snapshot should be used for calibration purposes (i.e., should be part of both long-run average default rate computation sample and calibration sample) or if it should be set aside for the out-of-time performance test. Moreover, it is not clear whether a partial overlap of the validation and calibration sample would satisfy the requirement of Article 175(4)(b).

Answer

As per Article 175(4) of Regulation (EU) No 575/2013 (CRR), institutions shall establish a rigorous statistical process including out-of-time (OOT) and out-of-sample (OOS) performance tests for validating the model. In particular, institutions need to develop robust models to allow for stable model use across time, and thus to a certain extent across changing environment or economic conditions. These tests are related to the (re-)development of the model in the risk differentiation step, while the data requirements from Article 179, 180, 181 and 182 CRR are related to the risk quantification.

Original source: European Banking Authority, Q&A ID 2023_6798

This Q&A is published by European Banking Authority and is non-binding. It does not constitute legal advice. Updated weekly from official ESA sources.

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