Model Validation

Abstract

The internal validation of rating systems is part of the general framework for rating system controls. According to both Italian and international regulatory requirements, validation activities should not be confined to empirical validation methods and tests, but should assess the overall functioning of the rating system along different dimensions that include method, the IT system and data quality, and processes and governance. Following the Basel Committee on Banking Supervision guidelines (2006, p.109), to comply with the normative framework, “banks must have a robust system in place to validate the accuracy and consistency of rating systems, processes, and the estimation of all relevant risk components. A bank must demonstrate to its supervisor that the internal validation process enables it to assess the performance of internal rating and risk estimation systems consistently and meaningfully.”