Document ID: chunk:federal_register_of_legislation:F2024L01074:body:0:p33
Version: federal_register_of_legislation:F2024L01074
Segment Type: other
Provision Reference: 
Character Range: 89734–92725

1.          The requirements in paragraphs 30 to 35 of this Attachment apply to statistical models and other mechanical methods used to assign borrower or facility grades or pools, and in the estimation of PD, LGD and EAD.
 2.          Credit scoring models and other mechanical methods are permissible as the primary or partial basis of rating assignments and may play a role in the estimation of PD, LGD and EAD under the IRB approach. However, human judgement and oversight must also be used to ensure that all relevant and material information, including that which is outside the scope of any such model or other mechanical method, is also taken into consideration and that the model or other method is used appropriately. An ADI must have written guidance detailing how human judgement and model results are combined.
 3.          Where an ADI uses a statistical model or other mechanical method in its rating process, the ADI must ensure that the model or other method has good predictive power and that the Regulatory Capital requirement will not be distorted as a result of its use. The variables that are used in the model or other method must form a reasonable set of predictors. On average, the model must be accurate across the range of borrowers or facilities to which the ADI is exposed. There must be no known material biases.
 4.          An ADI must have in place a process for vetting data inputs into a statistical model, which includes an assessment of the accuracy, completeness and appropriateness of the data specific to the assignment of a borrower or facility grade or pool.
 5.          An ADI must ensure that the data used to build its models are representative of the population of the ADI's borrowers and facilities.
 6.          An ADI must have documented policies and procedures for reviewing model-based rating assignments. These policies and procedures must focus on finding and limiting errors associated with known model weaknesses. The ADI must make credible ongoing efforts to improve the model's performance.
 7.          An ADI must undertake a regular cycle of model validation that includes monitoring model performance and stability, reviewing model relationships and testing model outputs against outcomes.

Documentation of rating system design
 1.          An ADI must document the design and operational details of its rating systems. Documentation must evidence the ADI's compliance with minimum requirements and address:
        1.           portfolio differentiation;
        2.           rating criteria;
        3.           responsibilities of parties that assign ratings to borrowers and facilities;
        4.           the definition of what constitutes a rating override;
        5.           parties that have the authority to approve overrides;
        6.            frequency of rating reviews; and
        7.           management oversight of the rating process.
 2.          An ADI must document the rationale for its choice of