IRB or Standardised Approach Under Basel IV: Insights from a Financial Services Round Table Event

Every now and then this topic comes back in board discussions at banks: Is it still worth it to have an IRB status? We are spending so much time, money, and resources to be compliant. In March 2024, ADC organised a round table event on the topic of IRB or Standardised Approach under the new Basel IV regulations coming into place 1 January 2025. The participants were Dutch mid-sized banks: Volksbank, NIBC, KNAB, Handelsbanken, Triodos Bank and NN Bank. 

Maintaining an Internal Ratings-Based (IRB) status for banks is a complex task due to several interconnected factors. Firstly, IRB models are highly complex and require sophisticated methodologies to accurately assess credit risk. Banks must continuously invest in data quality, model development, and model validation processes to ensure the robustness and accuracy of their IRB models.

Secondly, regulatory compliance adds another layer of complexity. Banks must navigate a complex regulatory landscape, including stringent requirements such as the EBA Guidelines. Meeting these regulatory expectations demands high quality documentation, transparent governance structures, and ongoing communication with regulators. Banks should dedicate resources to ensure smooth communication with the regulator and guide Internal Model Investigations and on-site inspections.

Additionally, IRB status brings increased scrutiny from both regulators and stakeholders, necessitating a culture of accountability and transparency within the organisation. There must be a clear split between the three lines of defence. These clear splits in responsibilities are especially a challenge for mid-sized banks. The combination of data requirements and regulatory demands makes maintaining an IRB status a challenging endeavour for banks.

Effective data management practices are essential for ensuring the security and integrity of this data. The right data platform creates a solid foundation for compliance and risk management operations. All participants agreed that data management is becoming more and more important, and has more focus within the bank, including C-level.

However, this is not an easy job. Banks often struggle with siloed data spread across multiple systems and departments. Many banks still rely on outdated legacy systems that were not designed to handle the volume and complexity of modern data. Integrating and modernising these systems poses significant technical challenges, requiring substantial investment in infrastructure and expertise. Overcoming these obstacles requires a concerted effort, involving investments in technology, talent, and data governance frameworks.

In short, yes. All participants agreed that the capital and risk management benefits of the (A-)IRB status are beneficial (depending on the business model/portfolio of the bank), even with new regulations coming in. However, there are a few side remarks, outlined below.

• High data quality, and in particular default data, is a must. External data sources can be considered, but representativeness is becoming an issue.
• There are quite a few implications for data management/modelling teams. The necessary knowledge and skills are a requirement to maintain the status.

Lastly, the gap between Standardised Approach (SA) and IRB becomes less because the basic requirements (e.g. data management) for SA increased. Therefore, the incremental costs for getting the IRB status are worth the money.

Are you interested in discovering how ADC can assist your organisation? ADC has extensive experience supporting Internal Model Investigations, model development, and data management. To learn more, please contact Gerrit van Eck (Principal, Financial Services).