Internal models approach for market risk
What is an internal models approach for market risk?
This approach allows approved financial institutions certain freedoms to forego external metrics and use their own approach of market risk evaluation, particularly risks imposed by changes in the economy, financial markets and the evolution of technology.
Where have you heard about an internal models approach for market risk?
Since the EU referendum, internal models have been topical as banks face the prospect of failing to achieve regulatory approval for their internal model approaches, in light of uncertain economic markets and political landscapes.
What you need to know about the internal models approach for market risk.
A regulated bank's internal model to assess market risk must be approved by a financial regulator.
The UK's financial regulator of banks is the Bank of England's Prudential Regulation Authority (PRA).
When a bank uses internal models to calculate its risk-weighted assets (RWAs), the guiding principle of the approach is that they can more accurately analyse risk factors and take control more efficiently.
The danger of using the internal models approach is that it could increase inconsistencies and unnecessary variation.