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NVB Reaction to 'CEBS Consultation technical aspects on diversification under Pillar 2'

Core Content

The Dutch Bankers' Association (NVB) has responded to the CEBS consultation on the technical aspects of diversification under Pillar 2 of the Basel Accords. The NVB supports the consultation as a step in the right direction but highlights several areas where improvements or clarifications are needed.

Main Views

The NVB emphasizes the importance of diversification as a sound practice for financial institutions and views it as a critical component of the Internal Capital Adequacy Assessment Process (ICAAP). They stress that:

• ICAAP is solely the responsibility of the individual bank and should reflect the institution's risk appetite, which is a fundamental element of strategic planning and internal solvency views.
• Robustness of the capital model, especially in terms of correlation estimates, is more important than stability, as correlation parameters can and should change with market conditions.
• Estimation of diversification should not be conflated with claiming diversification benefits, as the latter may imply a misleading or overly optimistic interpretation.
• Transferability of risks is a legal matter and should not be part of the technical aspects of diversification. If included, CEBS should provide separate guidelines.
• Diversification should be clearly categorized into intra-risk and inter-risk types, and the NVB suggests a more structured approach in the consultation paper.

Key Information

General Comments

• The NVB supports the CEBS approach but believes the document should:
  • Start with risk appetite in sections 1 and 5.2.
  • Focus more on methodologies for estimating diversification benefits rather than general capital model compliance.
  • Use "estimate(d) diversification" instead of "claim(ed) diversification".
  • Replace "stable" with "robust" in correlation estimates.
  • Include more specific guidance on expert-based estimates for diversification, especially for operational risk.

Specific Comments

• Section 1.3 and 3: The NVB questions the added value of discussing conservative risk margins, as the methodology should reflect the institution’s risk appetite.
• Section 1.4 and 2.3: These sections are considered redundant, as internal models are already validated against well-defined criteria.
• Paragraph 36: The NVB points out that the quality of position data is missing in the discussion on data quality.
• Paragraph 38: Correlation matrices are only applicable for market risk calculations.
• Paragraph 40: The term "reasonably stable" should be replaced with "robust".
• Paragraph 52 and 55: The NVB reiterates that adequate risk reflection is not necessarily conservative. Applying overly conservative parameters can lead to skewed risk-return analyses.
• Section 3.2 and 3.3: The NVB requests more specificity on the issues related to stress testing and sensitivity analysis.
• Section 4 paragraph 63: The validation process should be applied to the model as a whole, not just the diversification parameters.
• Paragraph 68/69: The NVB raises concerns about the reliability of back testing for tail events, which occur infrequently, and suggests a yearly comparison of internal and Pillar 1 capital calculations.

Conclusion

The NVB advocates for a more nuanced and precise approach to modeling diversification under Pillar 2. They believe that the consultation should reflect the internal decision-making of banks, focus on methodologies rather than generic compliance, and ensure fairness across institutions by applying consistency in regulatory expectations.