Modeling capital requirements and provisions

This book aims to present the readers with the solutions currently implemented at the international, European and Romanian level for determining capital and provisions requirements, according to the Basel recommendations, international accounting standards (IFRS 9), European directives and regulations and the legal banking framework in Romania. The team that developed this course has extensive experience in validating internal models developed by banks and in designing, within the National Bank of Romania, models for monitoring credit risk.

Modeling capital requirements has evolved over the past decade from a luxury used by a small number of banks to a necessity. Most banks have given up using the standard approach, where risk weights are explicitly established in the regulatory framework, in determining the minimum capital requirement. Instead, they use the approach based on internal models, where risk weights are calculated by each individual institution based on its own portfolio profile. In addition to the modeling required to quantify capital requirements, the implementation of the new IFRS 9 accounting standards, mandatory from 2018 in all European Union countries, requires that the provisioning requirement be calculated by estimating the expected credit risk. As a result, all banks in the EU, including Romania, have built models to quantify the probability of default.

Considering the increasingly important role of internal models in contemporary banking activity, we consider that the development of a course that would present both the modeling process of capital and provisioning requirements, as well as the validation of those models, would be useful for at least three categories of readers: students who want to deepen the modern notions of banking, employees in the banking sector or in the field of consulting involved in the calculation of capital requirements and provisions, who may find elements of support for their work in this course, and staff from the central bank dealing with the validation of banks' internal models or the supervisory and evaluation process.