Regulatory approval of internal risk models

There are good reasons for submitting an internal risk model for regulatory approval.

• An internal model provides a permanent improvement and consistent risk management by unifying internal and external risk management.
• The waiving of the standard approach for the calculation of market risk simplifies the business processes between the risk controlling and the regulatory reporting departments.
• Regulatory approval of your company's internal market risk model sends a clear signal about the excellent quality of your risk management methods and thus promotes rating agencies', clients' and business partners' perception of your company.
• Often, the minimum regulatory capital requirements for general and special market risks can be reduced significantly on obtaining approval of the internal risk model.

Cost/benefit analysis

The decision whether or not to implement an internal market risk model should take into account the corresponding costs and benefits. We supported several clients in this decision making process by preparing pilot studies. Among other things

• we analysed the current market risk model and deduced the action required to bring the model up to current standards, both with respect to functional and technical requirements
• we performed model calculations in order to estimate the reduction of regulatory capital to be expected from the implementation of an internal market risk model
• we set up project plans and deduced budget estimates for entire projects

We would also be pleased to support your institution in doing this.

Preparing for the review process 

The path to successful approval is not an easy one. The key challenges are often posed not by theoretical or functional aspects of how market risk is calculated. Obstacles in obtaining regulatory approval are often issues like technical stability of the risk management process, stability of data flows, organisational issues, or the integration of the risk model within the risk control and risk limitation processes of the bank. 

We accompany our clients from model inception until regulatory approval. In doing so, we put special emphasis on remedying issues from previous supervisory reviews. For example, in the past we have dealt with the following aspects:

• documentation and optimisation of processes
• quality assurance of data flows
• completion of documentation
• validation of the risk model
• integration of new financial products within the internal model
• compliance with all applicable regulatory requirements 

Comprehensive documentation is to be provided to the supervisory authorities before the review process begins. This documentation has to be prepared, updated and compiled. In the final phase of the review process, all staff involved must be prepared for the review itself and related meetings. Often, analyses and additional documents need to be produced on short notice during the review process.

We are able to support you in all of these areas, based on the practical experience we have gathered since 1998. We are familiar with the challenges and practical side of regulatory reviews. In Germany we have been involved in over half of all approved internal models and have provided direct support to a number of clients during their process of obtaining regulatory approval. 

We believe that our experience can make a true difference in the implementation of an internal market risk model, and we would be glad to put our experience to good use for the implementation of your internal model.

After successful approval

Even after an internal model has been approved by the supervisory agency, adjustments or improvements may be required. For example, to implement changes required by supervisory reviews or to expand the model to meet regulatory capital calculation requirements not previously approved in the case of a partial use model. Among other things, we have supported our clients in the following areas:

• obtaining regulatory approval for the calculation of specific interest rate and specific equity risk figures
• modelling of incremental default risk charge and incremental risk charge
• improving the modelling and speeding up the calculation of market risks for complex derivatives (e.g. for Bermudan Swaptions or path-dependent interest rate derivatives)
• improving the risk calculation for plain vanilla options and exotic options (e.g. by expanding the risk calculation by taking into account volatility smiles)