Document Properties
- Type of Publication: Implementation Note
- Category: Capital
- Date: January 2006
- No: A-1
- Audiences: Banks / BHC / T&L
I.
Introduction
This document outlines the key principles, requirements and steps for the
approval of Internal Risk Rating Systems (Rating Systems) for the internal
ratings-based (IRB) methodology and minimum regulatory capital calculation
outlined in Chapter 5 of the Capital Adequacy Requirements (CAR)
Guideline A-1. Approval requirements are outlined for Advanced and
Foundation IRB approaches, for both domestic institutions and foreign bank subsidiaries.
This document elaborates on the CAR guidance by setting out the approval
framework that will permit institutions to demonstrate their level of
adherence to the IRB minimum requirements.
Particular emphasis is placed on those institutions wishing to use the IRB
approach at the initial implementation date of the new Basel framework .
However, the approval framework may be generalized in future to support
those institutions that subsequently apply for IRB approval after the
implementation date of the new Basel framework.
II.
Background
Chapter 5 of CAR Guideline A-1 sets out the minimum requirements for
institutions to be eligible for the IRB approach. The Guideline also sets
out expectations with respect to the implementation timetable and, in
particular, the parallel reporting period.
OSFI recognizes that IRB approval work will require careful planning to
leverage the limited time that exists prior to the implementation date of
the new Basel framework. Consequently, the purpose of this document is to
advise institutions on the nature of the approval process, including the
key principles, the overall framework, and the key milestones and steps
for IRB implementation.
III.
Approval Principles
OSFI proposes an approach that will support timely implementation of IRB
by addressing the eight principles noted below.
The approval framework will:
-
Be based on an institution’s self-assessment of compliance and should
be performed on a consolidated basis (i.e., the framework should be
consistent with OSFI’s supervisory approach), subject to OSFI standards
regarding the measurement of capital for material subsidiaries of
institutions.
-
Promote a build-up of key information relating to Rating Systems
throughout implementation and thereby avoid excessive ‘loading’
challenges, i.e., the framework will be comprehensive and will permit
components of approval to be staggered over time.
-
Support initial approval and provide for the monitoring of ongoing
compliance with the IRB minimum requirements, i.e., the framework will be
dynamic.
-
Deliver an ultimate approval decision that is consistent with the
findings and experience of the implementation process, i.e., the framework
will produce a “no surprises” approval decision.
-
Promote feedback to institutions in order to support implementation
efforts and, where applicable, contingency planning, i.e., the framework
will support ongoing dialogue with institutions.
Be designed to address the many and varied institution-specific issues
and, where applicable, support “defect and cure”, i.e., the framework will
be flexible.
-
Be designed to accommodate future approval applications, post
implementation of the new Basel framework, i.e., the framework will be
generally applicable.
-
Support the design and execution of a supervisory plan in coordination
with applicable host-country supervisors and home-country supervisors for
foreign bank subsidiaries, i.e., the framework will support the Basel
Committee’s cross-border principles for Basel II implementation (particularly Principle 6).
IV. Key
Phases
The key date that anchors the approval process is November 1, 2007, which
is the start date (the Implementation Date ) for final or
‘live’ capital reporting under Pillar 1 of the new Basel framework. While
this date provides the overall approval timeline for institutions, OSFI
recognizes that it will be important to provide institutions with other
interim key dates for planning purposes. Please refer to Appendix I for
details.
Given the approval principles and the targeted Implementation Date, OSFI
will use an approval process that is broken down into five key phases as
illustrated below:
Table 1: Five Phases of the Approval Process
Phases
|
Description
|
Timelines for Institutions with a Oct. 31 Year-end
|
Timelines for Institutions with a Dec. 31 Year-end
|
Phase 1
|
Monitoring of institutions’ implementation efforts
|
November 1, 2004 to January 31, 2006
|
N/A
|
Phase 2
|
Formal application and preparation for ‘meaningful’ parallel
reporting
|
February 1, 2006 to July 31, 2006
|
April 1, 2006 to September 30, 2006
|
Phase 3
|
‘Meaningful’ parallel reporting and completion of OSFI review for
approval
|
August 1, 2006 to July 31, 2007
|
October 1, 2006 to September 30, 2007
|
Phase 4
|
Approval for Pillar 1 credit risk capital purposes
|
August 1, 2007 to December 31, 2007
|
October 1, 2007 to February 29, 2008
|
Phase 5
|
Monitoring of ongoing compliance
|
From November 1, 2007
|
From January 1, 2008
|
The following provides further detail on the five phases illustrated in
Table 1.
Phase 1: Monitoring of Institutions’ Implementation Efforts
The objective of Phase 1 is similar for both domestic institutions and
foreign bank subsidiaries; namely, it is the initial monitoring of
institutions’ implementation efforts. The means of achieving this
objective is different depending on whether or not the institution is a
foreign bank subsidiary. This distinction is designed to reflect the Basel
Committee’s cross-border principles. (Please refer to Section V of this
implementation note for approval steps required for foreign bank
subsidiaries during Phase 1.)
Phase 1 commences when an institution submits an initial self-assessment
(gap analysis) against the applicable IRB minimum requirements. This phase
is the initial stage of the approval process and involves various
activities that are the ‘ground-clearing’ work necessary for
implementation of the IRB approach. Consequently, institutions are in the
design and initial execution of implementation plans during this phase.
The objective of this phase is for institutions to develop rating systems
that are broadly consistent with the IRB minimum requirements.
As set out in Chapter 5 of the CAR Guideline A-1, institutions should have
a sufficient track record in ‘using’ internal rating systems that are
broadly consistent with the IRB minimum requirements for three years prior to the Implementation Date (see Appendix 1 for details). However,
OSFI will exercise its national discretion and take a pragmatic view of
this requirement in the near term during the transition period by reducing
this requirement by one year, to two years, i.e., institutions should be
broadly in line with the IRB minimum requirements by November 1, 2005.
Institutions are expected to perform sufficient analysis for project
planning and execution purposes during Phase 1. Further, institutions
should demonstrate that they have undertaken key project planning tasks,
and have commenced execution of project plans that require sufficient lead
times. Consequently, Phase 1 can be broken down into two parts:
Part 1A: Institution initial self-assessment (gap analysis) and associated
project planning
To prepare for IRB implementation, an institution is required to conduct
an initial assessment of its adherence to the IRB minimum requirements
(Gap Analysis #1) . The institution should submit this assessment to OSFI
for review. (Following an institution’s submission, OSFI will schedule
regular meetings to facilitate monitoring of implementation efforts
through to the Implementation Date of the new Basel framework).
Part 1B: Institution proposed rollout plan for IRB implementation
In line with the new Basel framework, OSFI recognizes that it will not
likely be practical to implement the IRB approach across all material
asset classes and business units at the same time. OSFI will therefore
permit institutions to adopt a phased rollout of the IRB approach across
the banking group, subject to the submission of an appropriately designed
plan by the Rollout Plan Date (i.e., November 1, 2004).
In order for the rollout plan submission to be meaningful, OSFI believes
it should meet certain de minimus standards and be performed on a
consolidated basis. Consequently, institutions should ensure that the
following information is included as part of the overall rollout plan:
The adoption plan, specifying to what extent and when the institution
intends to roll out IRB across the following dimensions:
-
asset classes within the same business unit (or, in the case of
retail exposure, across individual sub-classes);
business units in the same banking group; and
applicable legal entities.
In the context of (a)(a) through (a)(c) Text for screen readers: (a)(a) = (1)(1) and (a)(c) = (1)(3) above, the number of rating
systems employed and their respective applications.
In the context of (a)(a) through (a)(c) Text for screen readers: (a)(a) = (1)(1) and (a)(c) = (1)(3) above, the measures of
materiality assumed, including a measure of “Qualifying Assets” and a list of waivers and exemptions .
Key milestones and timelines for IRB implementation throughout the
transition period (and, where applicable, beyond the transition period).
Key assumptions, including project management requirements, such as
budget and resource plans.
Following plan submissions, OSFI will review and discuss rollout plans
with institutions to ensure they are robust and aggressive, yet realistic
and that “waiver” applications are clearly defined and appropriate in the
overall context of IRB rollout.
Part 1A and Part 1B should be consistent, i.e., the implementation efforts
and project planning should be consistent with the rollout plan proposal.
When taken together to form Phase 1, the associated implementation effort
should prepare the institution for IRB implementation by the
Implementation Date of the new Basel framework (i.e., November 1, 2007 ).
Consequently, where an institution has completed Phase 1 satisfactorily,
it will proceed to the next phase.
Phase 2: Formal Application and Preparation for ‘Meaningful’ Parallel
Reporting
Phase 2 is the formal application phase of the approval process. To
commence Phase 2, institutions will submit an application package to OSFI
by the Formal Application Date (i.e., February 1, 2006) . The package
should include the following information as at October 31, 2005:
A cover letter from the Chief Risk Officer, addressed to OSFI. The
letter will include the following information:
the status of the institution’s implementation efforts and level of
adherence to the IRB minimum requirements as at October 31, 2005,
including those parts of implementation not yet finalized;
information on the nature of any and all representations made to
the Audit and Risk Committees of the Board in respect of the IRB
implementation and approval process.
Completed self-assessment documentation that includes:
a description of the self-assessment process;
a description of self-assessment assumptions relating to
materiality, exemptions and ‘waivers’;
a completed set of risk rating system self-assessments; and
a completed model inventory for non-retail exposures.
Applications for waivers and exemptions, as applicable.
Applications for applicable domestic subsidiaries that also intend to
report on an IRB approach under the new Basel framework, including
information on the composition of credit assets within these entities and
the application of internal risk rating system methodologies.
A ‘refreshed’ or updated rollout plan.
Following the submission of the application package, institutions will
also submit a letter to OSFI from the Chief Internal Auditor by March 31,
2006. The letter will provide an assessment in the form of negative
assurance, based on:
Work conducted to that point in time, observations and other audit
procedures, on the institution’s progress towards adherence with all IRB
minimum requirements.
A review of business and/or management’s self-assessment made as part
of the formal application, including the self-assessment process developed
and implemented by the risk and/or business management (as applicable).
In addition to the cover letter, the institution will submit:
A description of the work performed to date by internal audit in
respect of an institution’s adherence to the IRB minimum requirements.
Where internal audit work is performed, the internal auditor’s opinion
should also be included as part of the approval package.
Details of internal audit plans during the parallel reporting period
in respect of IRB implementation.
As part of the supervisory process, OSFI will review institutions’
application packages. In particular, OSFI will want to understand the
process used by an institution to demonstrate its adherence to the IRB
minimum requirements. During the review process, institutions will be
expected to continue their implementation efforts as outlined in the
agreed rollout plans. Where applicable, OSFI will notify institutions of
material approval issues that are identified throughout this process.
Otherwise, once an institution has completed this phase satisfactorily, it
will progress to the next phase.
Phase 3: Parallel Reporting and Completion of OSFI Review for Approval
The parallel reporting period for IRB institutions covers five quarters
(i.e., Q4 2006 to Q4 2007 inclusive) prior to implementation and
involves institutions reporting on a dual basis to cover both the new
capital calculations as well as the existing capital calculations .
OSFI recognises that this period of dual reporting will provide
institutions with a critical amount of time to complete IRB
implementation. Consequently, Phase 3 will provide OSFI with an
opportunity to complete its outstanding approval work.
Where applicable, OSFI will notify institutions of material approval
issues that are identified throughout this process. Once an
institution has completed this phase satisfactorily, it will progress to
the next phase of the approval process.
Phase 4: Approval for Pillar 1 Credit Risk Capital Purposes
This penultimate phase involves the IRB approval decision. While OSFI
recognises the need to signal its approval decision in advance of the
Implementation Date, it also believes that an ultimate approval decision
will need to be based on a review process that takes into account the
findings of the entire parallel reporting period. Consequently, OSFI will
provide a two-step approval decision:
The first step will be an approval decision that is conditional on the
satisfactory completion of the parallel reporting period and
self-assessment process. This decision will be communicated to
institutions by the Conditional Approval Date (i.e., by August 1, 2007).
The second step will be a reconfirmed and final approval decision,
which will be given to institutions by the Formal Approval Date (i.e., by
December 31, 2007), based on the submission of an appropriately revised
and updated application package submitted to OSFI by October 31, 2007.
The revised and updated application package should include a final
assessment as at July 31, 2007. The application package submitted should
refresh all areas identified in Phase 2, including:
-
Confirmation that the Board and Senior Management have received
appropriate representations in order to fulfil their responsibilities
relating to IRB approval; and
-
An opinion from Internal Audit as to the design and effectiveness of the
internal controls to ensure adherence to all applicable IRB minimum
requirements.
An IRB approval decision will mean that the institution can report on IRB
approaches for Pillar 1 credit risk purposes (subject to the provisions of
the institution’s rollout plan) and can therefore progress to the next
phase of the approval process, namely, post-implementation monitoring.
Phase 5: Monitoring of Ongoing Compliance
To be eligible for an IRB approach, an institution should demonstrate to
OSFI that it is in compliance with the minimum requirements at the outset
(i.e., from November 1, 2007 ) and on an ongoing basis.
Consequently, OSFI will expect institutions to demonstrate continued
compliance with the IRB minimum requirements after the Implementation Date
of the new Basel framework.
Once an institution has been approved for IRB, it will be required to
reconfirm its adherence to the IRB minimum requirements on an annual basis
throughout the Transition Period, i.e., the three-year period immediately
following the Implementation Date. In particular, OSFI requires, on an
annual basis, a letter from the Chief Risk Officer confirming the
following:
The institution’s level of adherence to the IRB minimum requirements.
The status of the institution’s rollout plan.
Changes in materiality thresholds, waivers and exemptions (if
applicable).
OSFI believes that this approach will provide an opportunity to review the
execution of rollout plans, as well as address other approval issues that
are identified in the early years of implementation.
Throughout the Transition Period, monitoring will also include periodic
reviews of adherence to the IRB minimum requirements. Also, where there
are material changes to the risk rating system, institutions will be
expected to undertake reviews of their applications and compliance with
the minimum requirements and make these available to OSFI for its review.
V.
Additional Considerations
1. FIRB Institutions
All IRB approval principles, requirements and steps described in this
document apply to both AIRB and FIRB approaches. OSFI expects that
self-assessment for the FIRB approach will reflect specific elements
related to the FIRB requirements.
2. Foreign Bank Subsidiaries
The approval of foreign bank subsidiaries will be performed in line with
the Basel Committee’s cross-border principles for Basel II implementation.
In particular, OSFI will work with applicable home-country supervisors to
avoid performing redundant and uncoordinated approval work. In order to
streamline the approval process and limit the burden on foreign bank
subsidiaries, wherever possible, OSFI will review a number of factors in
cooperation with home- country supervisors, such as the risk profile of
the Canadian subsidiary, the location of rating system expertise, the
composition of the local portfolio, and the respective application
packages of home-country supervisors.
(a) Application Package
OSFI expects a simplified application package for foreign bank
subsidiaries. The application package will include the following summary
level information as it relates to Canadian operations:
A cover letter from the Chief Risk Officer of the foreign bank
subsidiary. The contents of the letter are the same as for domestic
institutions (see Section IV, Phase 2 (a) Text for screen readers: a = 1). In addition, the letter
should:
indicate the credit risk approach to be adopted by the parent
institution on a consolidated basis for reporting under the new Basel
framework;
describe any differences in Pillar 1 credit risk approaches
between the parent institution and the foreign bank subsidiary (if
applicable);
explain the high-level division of responsibilities between the
parent institution and foreign bank subsidiary, as they relate to
implementation of the new Basel framework and the self-assessment
process.
-
A cover letter from Chief Internal Auditor. The contents of the
letter are the same as for domestic institutions (see Section IV Phase 2
(f) to (i) Text for screen readers: f = 6 and i = 9). In addition, the letter should:
describe in summary form internal audit work performed by the
parent institution and the foreign bank subsidiary, respectively; and
indicate broadly the division of responsibilities between the
parent institution and the foreign bank subsidiary in respect of
internal audit work.
A summary of self-assessment results that includes a brief
description of the self- assessment process.
Applications for waivers and exemptions, if applicable.
A high-level rollout plan for the foreign bank subsidiary. The
rollout plan should address key dependencies between the parent
institution and foreign bank subsidiary in terms of deliverables and
timelines (see Section IV, Phase 1, Part 1B).
Where possible, OSFI will continue to work with applicable home-country
supervisors on a case-by-case basis to further examine ways of reducing
the scale of this application package.
(b) Timelines
The five approval phases described in Section IV of this document are
broadly applicable to foreign bank subsidiaries. However, Phase 1 of
Section IV has been modified as follows:
An initial self-assessment or gap analysis will not be required for
foreign bank subsidiaries.
The high-level rollout plans for the foreign bank subsidiary will
be submitted as part of the formal application package by April 1, 2006
(for institutions with December 31st fiscal year-ends).
The schedule of meetings to monitor institution’s implementation
efforts will be determined on a case-by-case basis, based on discussions
with the applicable home-country supervisor.
3. Defect and Cure
OSFI believes the approval framework will provide sufficient time and
opportunity to address most approval issues because the interim milestones
will provide for a ‘defect and cure’ approach well in advance of the
implementation date.
However, OSFI also recognises there may be some exceptional circumstances
that could potentially prevent an institution from progressing to IRB (and
therefore should report on an alternative approach for Pillar 1 credit
risk capital reporting purposes). Consequently, OSFI will use the ongoing
review process, both before and after the implementation date of the new
Basel framework, to advise institutions on preparing for contingencies and
alternative outcomes.
Where material approval issues exist after the approval of IRB (e.g., an
institution fails to satisfactorily implement its rollout plan), OSFI may
reconsider the institution’s eligibility for IRB. Moreover, for the
duration of any non-compliance, OSFI may also consider the need to take
other appropriate supervisory action.
Appendix
I: Approval Process Milestones
(for approval by fiscal year-end 2007)
Phases
|
Milestone
|
Description
|
Institutions with October 31 Year- ends: Key Dates for IRB
Approval
|
Institutions with Dec 31 Year-ends: Key Dates for IRB Approval
|
1
|
2
|
3
|
4
|
5
|
Phase 1
|
Start Date (‘Informal’ Application Date)
|
An institution enters the IRB approval process. This date should
be at least 3 years prior to the implementation date.
|
November 1, 2004
|
N/A
|
Rollout Plan Date
|
An institution submits its rollout plan for IRB.
|
November 1, 2004
|
N/A
|
Phase 2
|
Formal Application Date & Preparation for Meaningful Parallel
Reporting
|
An institution submits its formal IRB application to OSFI.
|
February 1, 2006
|
April 1, 2006
|
Phase 3
|
Parallel Reporting Period Start Date
|
The start date of the parallel reporting period.
|
August 1, 2006
|
October 1, 2006
|
Phase 4
|
Conditional Approval Date
|
An institution will be conditionally approved for IRB, subject to
satisfactorily completing the parallel reporting period.
|
August 1, 2007
|
October 1, 2007
|
Implementation Date
|
The start date for the new
Basel framework.
|
November 1, 2007
|
January 1, 2008
|
Formal Approval Date
|
An institution will be formally approved for IRB under Pillar
1 of the new Basel framework. This date should be within
two months of the implementation date.
|
December 31, 2007
|
February 29, 2008
|
Phase 5
|
Transition Period
|
The start and end dates for the
Transition Period.
|
November 1, 2007 - October 31, 2010
|
January 1, 2008 - December 31, 2010
|