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Internal models


Are proprietary traders allowed to use an internal model to calculate the capital requirements for specific risks or risk components, instead of using the standardised approach described in the CRR? How does the process for approval of an internal model work?

Published: 13 February 2024


For proprietary traders meeting all the conditions mentioned in Article 96(1)(b) of the CRR, capital requirements based on Article 96(2) of the CRR are calculated as the sum of the risk-weighted items for credit risk, counterparty risk, market risk and credit valuation adjustment risk (CVA risk) and the fixed overheads requirement (FOR). See also part (1) of this Q&A – Capital requirements under the CRR.

For the calculation of the capital requirements for these risk-weighted items, the following internal models may be used instead of the standardised approach under the CRR for each risk item:

(a) Internal Models Approaches (IMA) for market risk, as referred to in Article 221 of the CRR;
(b) Internal Rating Based (IRB) for credit risk, as referred to in Article 143(1) of the CRR;
(c) Internal Model Methods (IMM) for counterparty credit risk, as referred to in Articles 283 and 361 of the CRR; and
(d) Advanced Credit Valuation Adjustment (A-CVA) for CVA risk, as referred to in Article 383 of the CRR.

An internal model can only be used after DNB has approved the model. DNB assesses an application for approval among others on the following elements:

(a) DNB requires a validation and an audit report that at least includes the CRR requirements;
(b) the suitability of the methodology, risk monitoring and governance of the internal model; and
(c) DNB analyses the portfolio to which the internal model applies among others on the following elements:

  • the significant share condition of the modelled risk factors relative to non-modelled factors;
  • whether the operational processes related to the internal model are flexible and adequate on among others pricing, decision-making, risk management, validation and calculation of capital;
  • the economic suitability of the internal model;
  • whether the internal model is suitable for risk prediction (e.g. by means of back-testing exercises and tests of the model in hypothetical and historical scenarios);
  • the IT infrastructure, the input data and the data used in developing the model, and
  • parallel run (back-testing results are required for market risk).

When applying for approval of internal models, you must also bear in mind the following:

  • one or more risks may be modelled internally while using the CRR standardised approach for other risks;
  • it is not permitted to switch between the standardised approach and the internal model for each reporting period (quarter);
  • as long as DNB has not approved the use of an internal model, reporting and capitalisation must be based on the standardised approach under CRR for the risk concerned;
  • applications for approval including all documentation must be submitted to DNB by means of the application forms available on DNB’s Open Book on Supervision/Digital Supervision Portal;
  • the application for approval must be complete; and
  • DNB requires a self-assessment in which the institution examines to what extent it already complies with the CRR.

The time needed to complete the approval trajectory for internal models depends on various factors, including:

  • the date of completion of the application;
  • the portfolios to be modelled, and
  • the complexity of the internal model or sub-model.

DNB emphasises that the approval trajectory is not an iterative process: an insufficiently detailed internal model will be disapproved.

DNB further refers you to the EBA's website for more information on internal models and the approval process.