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The paper deals with the question of how to restore lost confidence in the results of internal models (especially market risk models). This is an important prerequisite for continuing to use these models as a basis for calculating risk-sensitive prudential capital requirements. The authors argue that restoring confidence is feasible. Contributions to this end will be made both by the reform of regulatory requirements under Basel 2.5 and the Trading Book Review and by refinements of these models by the banks themselves. By contrast, capital requirements calculated on the basis of a leverage ratio and prudential standardised approaches will not be sufficient, even from a regulatory perspective, owing to their substantial weaknesses. Specific proposals include standardising models with a view to reducing complexity and enhancing comparability, significantly improving model validation and increasing transparency as to how model results are determined, also over time. The article reflects the personal views of the authors.

Regulatory Developments in Risk Management: Restoring Confidence in Internal Models