Internal Credit Risk Models For Assessing Capital Adequacy
August 13, 1998
Circular No. 11081

To All State Member Banks, Bank Holding Companies, and Branches and Agencies of Foreign Banks, in the Second Federal Reserve District:

The following is from a statement by the Board of Governors of the Federal Reserve System:

The Federal Reserve Board has issued a final report prepared by the System Task Force on Internal Credit Risk Models. The Task Force was created to assess potential uses of internal credit risk models within the supervisory and regulatory processes. The report describes current uses of internal models by major U.S. banking organizations, and outlines possible uses of the models for assessing bank capital adequacy.

The report concludes that, while improvements in credit risk modeling are occurring rapidly, important challenges exist with respect to model construction, data availability, and model validation procedures, so that near-term uses of the models within the regulatory process are limited. However, the report also concludes that models may, over the medium term, become useful in at least the following two roles:

The development of specific and practical examination guidance for assessing the capital adequacy of large, complex banking organizations, and

The setting of regulatory capital requirements against selected instruments that have largely evolved subsequent to adoption of the Basle Accord on risk-based capital, such as credit enhancements supporting securitization programs.

The Executive Summary of the report is available as a file. The full report is also available as a file.