27. An effective internal control system for credit risk assessment and measurement should include …

An effective internal control system for credit risk assessment and measurement should include:

• a. measures to comply with applicable laws, regulations, internal policies and procedures;
• b. measures to provide oversight of the integrity of information used and reasonably ensure that the allowances reflected in the credit institution’s financial statements and reports submitted to the competent authority are prepared in accordance with the applicable accounting framework and relevant supervisory requirements;
• c. well-defined credit risk assessment and measurement processes that are independent from (while taking appropriate account of) the lending function, which contain:
• i. an effective credit risk rating system that is consistently applied, accurately grades differentiating by credit risk characteristics, identifies changes in credit risk on a timely basis, and prompts appropriate action;
• ii. an effective process to ensure that all relevant and reasonable and supportable information, including forward-looking information, is appropriately considered in assessing credit risk and measuring ECL. This includes maintaining appropriate reports, details of reviews performed, and identification and descriptions of the roles and responsibilities of staff involved;
• iii. an assessment policy that ensures ECL measurement occurs at the individual lending exposure level and also, when necessary to appropriately measure ECL in accordance with the applicable accounting framework, at the collective portfolio level by grouping exposures based on identified shared credit risk characteristics;
• iv. an effective model validation process to ensure that the credit risk assessment and measurement models are able to generate accurate, consistent and unbiased predictive estimates, on an ongoing basis. This includes establishing policies and procedures which set out the accountability and reporting structure of the model validation process, internal rules for assessing and approving changes to the models, and reporting of the outcome of the model validation;
• v. clear formal communication and coordination among a credit institution’s credit risk staff, financial reporting staff, senior management, the management body and others who are involved in the credit risk assessment and ECL measurement process. This should be evidenced by written policies and procedures, management reports and minutes of committees involved such as management body or senior management committees; and
• d. an internal audit²³ function that:
• i. independently evaluates the effectiveness of the credit institution’s credit risk assessment and measurement systems and processes, including the credit risk rating system; and
• ii. makes recommendations on addressing any weaknesses identified during this evaluation.

4.2.2 Principle 2 — Sound ECL methodologies

Credit institutions should adopt, document and adhere to policies which include sound methodologies, procedures and controls for assessing and measuring credit risk on all lending exposures. The measurement of allowances should build upon those methodologies and result in the appropriate and timely recognition of ECL in accordance with the applicable accounting framework.

²³ Article 74 of Directive 2013/36/EU and EBA Guidelines on Internal Governance (GL 44).

1. Overview

1.1 References

1.2 Identified Requirements

1.3 Related Standards

2. Identified Requirements

3. Related Standards

• EBA - Published by the European Banking Authority at https://www.eba.europa.eu/