On April 19th, 2021, ECB published the results of the Targeted Review of Internal Models (TRIM), summarising findings and follow-ups of this multi-year project.

The TRIM review covered internal models for credit, market, and counterparty credit risk. Given that there are many internal models operating in banks, ECB focused on those significantly material and critical for risk-weighted assets (RWA) calculation. In the last few years, ECB Banking supervisory conducted 200 on-site investigations in 65 significant banks with internal models in place and identified over 5,000 findings. “This large-scale exercise, the ECB’s biggest project ever, contributes to a level playing field in European banking by ensuring internal models are reliable and their outcomes are comparable,” said Andrea Enria, Chair of the ECB’s Supervisory Board, quoted by ECB’s official press release. “It confirms that consistently implementing internal models is possible even within a supervisory area as large as the banking union. Banks are following through to correct deficiencies and fully comply with the requirements. Our guide to internal models will support them in that respect.”

In total, TRIM leads to a 12% increase in RWA, approximately €275 billion growth equivalent. That is, TRIM identified that more risks in significant institutions than estimated. According to ECB’s report, the Common Equity Tier 1 ratio of banks using internal models declined on average by about 70 basis points due to TRIM over 2018-2021.

In 2016, European Central Bank (ECB) launched the Targeted Review of Internal Models (TRIM) to raise concerns over the non-risk-based variability of the model outputs used for regulatory capital requirements calculation. Capital requirements are highly associated with a bank’s ability to react to unfavourable risks. Banks using the Advanced Internal Model Approach (A-IRB), which consist of more variables than its counterpart, usually are entitled to less requirement. The TRIM aims to ensure that the internal models used by supervised entities are reliable and comparable – differences in outputs occur only when the underlying risks, which are led by the difference in portfolio composition, are different.

In practice, remediation plans requested by TRIM Obligations are strongly linked to a bank’s ability to initiates changes within the organisation. Changes could range from policy establishment to on-site execution to documentation. As credit risk modelling is one of the most data-intensive domains in banking operations, many changes requested by TRIM Obligations touch upon issues regarding data quality and storage. Because the massive number of changes should be implemented within the regulatory timeline, the bank needs to ensure even tighter collaboration across the organisation, bringing more challenges during execution. A clear example is that in the pandemic time, more cross-organisational alignments are needed given a drastic increase in remote working.

As a consulting firm highly aware of changes in the financial sectors, we indeed see that ECB’s launch of TRIM has driven financial institutions towards a big load of changes in the risk management domain. With our proven and extensive record in driving transformation, we believe that we can add much value to our financial institutional clients, helping them firmly address challenges in their remediation plans implementation.

 

For more details of ECB’s TRIM report, please check the original article.