andreas dombret : to count or not to count – the future of internal models in banking regulation speech by dr andreas dombret, member of the executive board of the deutsche bundesbank, at the eba policy research workshop & quot ; the future role of quantitative models in financial regulation & quot ;, london, 28 november 2017. * * * 1. introduction ladies and gentlemen dear andrea enria thank you for the invitation and your kind introduction. after i accepted to give the keynote at this risk modelling conference, a colleague shared with me an unflattering comparison of financial risk modellers with weather forecasters. he asked : why do you think weather forecasters like financial risk modellers so much? his answer : because the only kind of storm less well predicted than hurricanes and tornadoes are financial storms. in my keynote today, i will frame this conference in a more positive tone, as i see a lot of merit in financial risk modelling – and in weather forecasting, too, for that matter. yet during and after the financial crisis we witnessed severe instances of risk model failure – where internal calculations of many banks grossly underestimated actual risks. remember for example the systematic underestimation of a market freeze or a price bubble before the subprime crisis broke. the many unexpected lawsuits pointed to further blind spots – all of which suddenly led to capital cushions melting away. however, focusing on these failures alone misses the fact that, overall, financial risk modelling has improved risk measurement substantially. it has inspired us to reconsider the role and the liberties of internal modelling. and this is partly why you are at today ’ s eba workshop – to improve internal models. your agenda includes challenging topics. my aim is far more modest. in my statement this morning i will take stock of risk modelling and the “ lessons learned ” from the financial crisis. i will highlight both the limitations and the strengths of internal modelling. second, i will present general principles that should guide future work. and, third, i will outline my take on where current and future eu projects on internal models should be heading. 2. financial crisis, regulatory reform and internal models but first, let ’ s take a step back. fifteen years ago, internal risk models were considered the gold standard for optimising capital allocation. what made them so successful was the efficient use of capital and their high risk sensitivity – which was made possible by granting banks substantial freedom in using their internal models for regulatory

have not overreacted and remained cool - headed. this is a positive sign. central banks, including the eurosystem, have reacted decisively to the situation with liquidity provisions and other measures. german banks do not report liquidity problems. the german financial system is stable and over the past years its resilience against adverse shocks has markedly improved. moreover, the universal banking model – a characteristic feature of the german financial system – has proven its robustness and stability. these structural achievements will help to cushion current tensions due to higher perceived counterparty risk and a necessary unwinding of positions on the market for credit risk transfer – both unavoidable outcomes in the face of an insolvency of one of the major market participants. the financial turbulence has created the most challenging situations for financial intermediaries, for central banks, for supervisory agencies, and for regulatory bodies in decades. and since the causes of the crisis are deeply rooted, a comprehensive coordinated response at the international level is evidently warranted. in this context, the financial stability forum – the fsf – in particular is playing a crucial role in the process of mitigating the ongoing difficulties and making the financial system more resilient to future shocks. the fsf was established in 1999, following a report by the then bundesbank president, hans tietmeyer. the fsf brings together senior representatives of national financial authorities ( for example, central banks, supervisory authorities and treasury departments ), international financial institutions ( such as the imf or the bis ), international regulatory and supervisory groupings ( for example, basel committee on banking supervision, international accounting standard board ), committees of central bank experts ( such as the committee on the global financial system ) and the european central bank. the fsf ’ s mandate is to assess vulnerabilities affecting the international financial system, to identify and oversee action needed to address these, and to improve coordination and information exchange among the various authorities responsible for financial stability. in doing so, the fsf aims to promote international financial stability, improve the functioning of financial markets, and reduce the tendency for financial shocks to spread from country to country, thus destabilising the world economy. the fsf seeks to give momentum to a broadbased multilateral agenda for strengthening financial systems and the stability of international financial markets. the necessary changes are enacted by the relevant national and international financial authorities. in a nutshell, the fsf acts as a central hub for all