European Central Bank Banking Supervision published an updated guide to internal models, incorporating changes introduced by Regulation (EU) 2024/1623 (CRR3) and clarifying how it assesses banks’ internal models used to calculate own funds requirements. The revised approach is positioned to support further streamlining of the internal ratings-based (IRB) model landscape and is accompanied by a plan to gradually increase proactive internal model investigations, while maintaining reactive investigations linked to bank-initiated model change requests. The July 2025 update refines and restructures earlier guidance based on industry feedback and supervisory experience, while stating it does not alter or exceed EU legal requirements. New supervisory expectations cover data governance and the use of machine learning techniques, credit risk internal model applications (including internal validation and audit processes, definition of default, probability of default quantification, downturn loss given default estimation and multi-component loss given default models), market risk models in the context of the fundamental review of the trading book under CRR3, and modelling exposure changes during the margin period of risk for margined trading under counterparty credit risk. The ECB also highlighted ongoing simplification trends, with rating systems down 18% between end-2022 and end-2024 and a roughly 30% drop for smaller portfolios, alongside a 3.3% fall in the share of modelled exposures and about a 25% reduction in planned sequential IRB roll-outs; CRR3’s transitional arrangement under Article 494d, valid until 10 July 2027, is cited as enabling further reversion to less sophisticated approaches, with the ECB inviting a single, consolidated application where possible after discussion with the relevant joint supervisory team. On supervision, proactive investigations are expected to become more frequent to address areas of concern and follow up on outliers, while an extensive review project like the Targeted Review of Internal Models is not considered necessary for now. Readiness checks for investigation will be tightened, including scrutiny of whether models have been implemented and tested in a non-production environment, and the ECB will place greater emphasis on internal control functions’ independent challenge and on excluding models with material deficiencies from application packages, with potential closer review of governance arrangements where applications are persistently poor quality.
European Central Bank - Banking Supervision 2025-08-13
European Central Bank Banking Supervision updates internal models guide for CRR3 and will increase proactive model investigations
The European Central Bank Banking Supervision updated its guide to internal models, aligning with Regulation (EU) 2024/1623 (CRR3) and clarifying the assessment of banks' internal models for own funds requirements. The update introduces new supervisory expectations on data governance, machine learning, and credit risk models, while highlighting a trend towards simplification in rating systems and modelled exposures. Proactive internal model investigations will increase, focusing on areas of concern and ensuring robust internal controls.