CEBS consults on diversification benefits of internal models

Level 3 committee starts public consultation on its technical approach to diversification of internal models

LONDON – The Committee of European Banking Supervisors (CEBS) has begun a public consultation on its proposed technical approach to understanding claims for diversification benefits arising from internal models used by supervised institutions for Pillar II purposes.

The paper presents current thinking on the areas of supervisory interest regarding an institution's management structure, organisation and internal controls, within the framework of risk diversification effects claimed under Pillar II. These considerations could form part of a broader assessment of economic capital models where they incorporate diversification assumptions. The paper mainly refers to commonly accepted modelling practices and does not necessarily mean the supervisors will address internal economic capital models used for Pillar II purposes with the same intensity of scrutiny as in regulatory approval of Pillar I models.

Given the technical and complex nature of diversification measurement, and the potential for evolution of the underlying models, parameters and risk characteristics, the paper concentrates mainly on the general qualitative environment in which diversification modelling takes place, and on the quantitative approaches supervisors may consider when assessing firms' own measures of diversification.The CEBS’s main aim of the paper is for it to provide a dialogue between supervisors and the industry to allow them to assess diversification claims and highlight more clearly the particular factors within a diversification framework where supervisors will need to be convinced of the claims’ validity.

The consultation is open to all interested parties and will run until October 31, 2008. A public hearing is set for September 8, 2008.