Sound practices for backtesting counterparty credit risk models

The Basel Committee on Banking Supervision has issued today a consultative document on Sound practices for backtesting counterparty credit risk models.

This supervisory guidance reinforces and explains some of the proposed changes to the Basel II framework included in the consultative document Strengthening the resilience of the banking sector, which was issued for comment in December 2009. Today's sound practices for backtesting paper provides additional information on supervisory expectations as well as recommendations to strengthen the backtesting of internal assessments of counterparty credit risk exposures.

Banks that have received supervisory permission to use internal model methods to calculate regulatory capital are required to validate their models on an ongoing basis. Backtesting is an integral element of the model validation process and the financial crisis has revealed that additional guidance in this area is required. The Committee believes that implementation of these sound practices will improve the backtesting of banks' models and, as a result, will enhance the resilience of individual banks and the financial system.

Comments on this consultative document should be submitted by 31 May 2010 by email (baselcommittee@bis.org) or by post (Secretariat of the Basel Committee on Banking Supervision, Bank for International Settlements, CH-4002 Basel, Switzerland).

A final version of this paper was released in December 2010.