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Study by the Basel Committee on the validation of internal rating systems

The revised Framework (Basel II) of June 2004 stipulates that, if using the IRB approaches, banks are to estimate the credit risk parameters (eg probability of default, loss given default) themselves. The banks are obliged to validate their rating systems themselves and are merely monitored by banking supervisors. While the methodology of internal rating systems for measuring individual default risks is already relatively well-advanced, there is still a considerable need for research on the methodologies for validating and measuring the performance of these models.

The Basel Committee therefore set up the Validation Group as a subgroup of the Research Task Force in June 2002. It is chaired by a member of the Bundesbank's Banking and Financial Supervision Department. The Validation Group's core task was initially to gain an overview of the rating systems used in practice and the validation procedures applied to these rating systems as well as to lay down a common terminology for validation issues. In addition, the Validation Group made contributions to the refinement of quantitative validation methods and developed principles for qualitative validation.

The Validation Group's initial findings were published in the article "Approaches to the validation of internal rating systems" PDF from the Deutsche Bundesbank's Monthly Reports in September 2003. The Group presented its final report PDF to the Basel Committee in December 2004. The report was published in February 2005.