Authorisation of risk models for calculating capital adequacy requirements

Banks and account-holding securities firms can use individual risk models to calculate their capital adequacy requirements, subject to FINMA’s authorisation.

The Capital Adequacy Ordinance (CAO) states that banks and account-holding securities firms must have sufficient capital to underpin the risks inherent in their business. Most institutions calculate their minimum capital requirement using standard approaches for market, credit and operational risks, but FINMA can authorise the use of individual models for one or more of these risk classes on request.

Authorisation requirements for risk models

To obtain authorisation for a proprietary risk model, a bank or account-holding securities firm must convince FINMA that the model appropriately captures all of the main risks inherent in its business. The model must also be firmly integrated into its internal risk control mechanisms and comply with all other prescribed quantitative and qualitative specifications. The Basel III international minimum standards serve as FINMA’s benchmark in this respect in accordance with the Capital Adequacy Ordinance. FINMA takes account of reports from audit firms or foreign supervisory authorities where necessary when assessing a request for authorisation.

Parallel calculations

Internal risk models based on individual approaches account for the special features of complex business operations better than the standard approaches. However, individual models are harder to compare, since they calculate the minimum capital requirement in different ways. For every model authorised, therefore, FINMA can demand a parallel calculation of the requirement using the standard approach (Art. 47 CAO). There is an additional safety net in the form of the deliberately non-risk-based leverage ratio.

Authorised risk models

Nine Swiss banks currently use authorised risk models to calculate their minimum capital requirement. Most of these are large institutions in supervisory categories 1 to 3. FINMA regularly reviews the application of authorised models and has them verified by audit firms.