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Part B - Use of internal models to measure market risks

B.7 Combination of Internal Models and the Standardized Methodology

Unless a bank's exposure to a particular risk factor, such as commodity prices, is insignificant, the internal models approach will in principle require banks to have an integrated risk measurement system that captures the broad risk factor categories (i.e., interest rates, exchange rates (which may include gold), equity prices and commodity prices, with related options volatilities being included in each risk factor category). Thus, banks which start to use models for one or more risk factor categories will, over time, be expected to extend the models to all their market risks. A bank which has developed one or more models will no longer be able to revert to measuring the risk measured by those models according to the standardised methodology (unless the supervisory authority withdraws approval for that model). However, pending further experience regarding the process of changing to a models-based approach, no specific time limit will be set for banks which use a combination of internal models and the standardised methodology to move to a comprehensive model.

The following conditions will apply to banks using such combinations:

  1. each broad risk factor category must be assessed using a single approach (either internal models or the standardised approach), i.e., no combination of the two methods will in principle be permitted within a risk category or across banks' different entities for the same type of risk (but see paragraph 16 of the introduction);

  2. all the criteria laid down in Part B of this paper will apply to the models being used;

  3. banks may not modify the combination of the two approaches they use without justifying to their supervisory authority that they have a good reason for doing so;

  4. no element of market risk may escape measurement, i.e., the exposure for all the various risk factors, whether calculated according to the standardised approach or internal models, would have to be captured;

  5. the capital charges assessed under the standardised approach and under the models approach are to be aggregated according to the simple sum method.

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