Targeted Review of Internal Models - TRIM
A significant effort of the SSM to contribute to a responsible use of regulatory capital models
As part of the setup of the Banking Union, supervision for the significant entities is is done by the Single Supervisory Mechanism (SSM). In this context the SSM launches in 2017 a series of investigations with a focus on banks’ internal models, the so called “Targeted Review of Internal Models” (TRIM).
Similar to the comprehensive assessment (CA) in 2014 and the Supervisory Review and Evaluation Process (SREP) since 2015, TRIM is one of the high priority projects of the SSM to harmonize supervision of the banks in the Eurozone. The ECB has been preparing this exercise since 2015. Each on-site mission will be staffed by at least six people and last over a period of at least ten weeks. While TRIM does not aim to increase RWA in general, the ECB expects that individual banks will need to address any gaps identified during the investigations in their compliance with regulatory requirements directly after completing the on-site mission.
Challenges for the financial industry
As part of the Basel Capital Accord, banks in Europe may use the opportunity to calculate risk-weighted assets (RWA) and required capital based on internal models as opposed to standardized models. These internal models are now in focus of supervisory scrutiny, covering the following risk types:
- Credit risk (IRB models)
- Market risk (IMA models)
- Counterparty credit risk (IMM models)
One of the SSM’s main objectives is to reduce the variability of risk weighted assets (RWAs) stemming from internal models to restore credibility and adequacy as the current design of internal models exhibit weaknesses from a supervisory perspective. Theses weaknesses are to be addressed by the TRIM exercise. It is expected that the consistency among banks’ methodologies will be increased and the credibility as well adequacy in capital requirements will be restored.
Banks need to demonstrate regulatory compliance with the model framework, including compliance to EBA RTS, ITS and Guidelines. For this purpose, the ECB has issued a TRIM Guide that will be adjusted during the exercise. Bank will have to prepare detailed data on the models ahead of the on-site investigations. Further, evidence of an adequate model validation processes has to be provided. Policies and procedures for model governance and data systems, including audit trails have to be available as well.
TRIM will help the ECB to identify best practices by horizontal analyses resulting in new minimum standards with the impact that banks will have to update their internal model approaches, especially banks that are outliers in the peer analysis.