The future of internal models

Over 400 industry professionals joined our recent hybrid webinar, The Future of Internal Models. This international event featured regulatory and banking experts discussing developments in credit risk modelling—particularly the balance between the Internal Ratings-Based (IRB) approach and the Standardised Approach, model governance, and the application of advanced modelling techniques.

Event highlights

The session opened with a keynote from Stephen Woulfe, Head of Division at the European Central Bank (ECB), who presented key updates on supervisory reforms. A panel discussion followed, featuring senior representatives from Santander, BBVA, ING, and Société Générale, moderated by Ángel Mencía.

The event also launched a joint industry survey, designed to collect insights on how institutions are evolving their modelling frameworks in response to regulatory and strategic pressures.

Keynote address: ECB supervisory reforms

Stephen spoke about major updates to the ECB’s model oversight framework, highlighting a cultural and operational shift toward efficiency and proportionality.

Key changes:

• New tiered classification of findings:
  • F1/F2: Low severity
  • F3/F4: Material severity (Effective from July 2025)
• Autonomous closure of minor findings: Banks may close F1 and F2 issues independently, with evidence retained for five years. Spot checks may apply.
• Focus on material risk: Supervisory attention will focus on more severe (F3/F4) findings.
• Trust and accountability: Greater autonomy comes with increased responsibility. Institutions are expected to uphold strong governance.
• Operational relief: The reforms aim to reduce administrative burden and encourage internal ownership of risk management.

IRB strategy and simplification

The panel explored how evolving supervisory expectations are leading banks to take a more selective approach to IRB adoption.

Key takeaways:

• Broad IRB coverage is being replaced by portfolio-specific strategies based on modelability, data quality, and cost-benefit considerations.
• Article 494d is a valuable tool for reverting to the Standardised Approach—but formal approval remains complex.
• Simplification should be strategic, aligning with both business goals and compliance needs.

Model governance and monitoring

Monitoring was identified as the cornerstone of effective model management.

Discussion points:

• Redevelopment should only be triggered by clear evidence from monitoring activities.
• Monitoring is becoming more granular, focusing on sub-model behaviour, data drift, and user interaction.
• Automation can improve efficiency but is best applied to routine processes—critical judgments still require human oversight.
• Institutions are shifting towards incremental model updates, supported by more agile governance structures.

Advanced modelling techniques and external data

While advanced analytics offer great promise, regulatory limitations restrict their use in IRB models.

Key insights:

• AI and ML are more common in non-regulatory tools such as early warning systems and application scorecards.
• Fintech competition is driving traditional banks to modernise development and validation processes.
• Internal validation functions are being enhanced with challenger models, explainability tools, and sensitivity testing.
• External datasets remain underutilised, especially for low-default portfolios—despite their potential to improve benchmarking and credibility.

Supervisory dialogue and strategic trade-offs

Panellists emphasised the need for open, strategic dialogue with supervisors, especially as institutions weigh the costs and benefits of IRB coverage.

Reflections:

• Simplification should be pursued without compromising model quality or governance.
• Even non-IRB portfolios require robust models for capital planning and credit decisions.
• Ensuring consistency across jurisdictions is essential for international banking groups.
• Strategic shifts in modelling should be board-level decisions, grounded in risk management best practices.

Take part in our joint survey

We invite industry professionals to share their perspectives in our short survey on the future of internal models: Take the survey

Your input will help shape a clearer understanding of evolving practices, challenges, and priorities in internal modelling.

Watch the webinar recording

View the full discussion, including Stephen Woulfe’s keynote and all expert panel insights: Watch now on YouTube