15. Systemic risk factors

Although interdependence between issuers is frequently modelled in a similar way to the regulatory IRB framework, using a combination of an idiosyncratic (i.e. individual) and one or more systemic risk factors, no modelling approach is prescribed by these Guidelines, provided that an institution meets all the relevant qualitative and validation requirements to ensure that its approach is suitably conservative.

If the model assumes different liquidity horizons, the evolution of systemic risk factors should be consistent and compatible across these different liquidity horizons.

The correlation between systemic risk factor(s) and individual issuer‟s „ability-to-pay process‟ may be difficult to estimate because they are not directly observable. Any estimation technique based directly or indirectly on observable market data (as in the case of listed equity) should be duly justified and documented.

Where an institution chooses a parametric formula assuming multiple systemic risk factors, thus better reflecting industry or regional concentration than when assuming a unique systemic risk factor, the choice of the parametric formula should be analysed and validated, for example by comparing the results of the current model with the outcome of a modified version of the same model that uses the IRB formula and where all systemic risk factors are perfectly correlated.