Adequacy of the methods and procedures of the validation function
Article 12
When assessing the adequacy of the validation methods and procedures for the purposes of the requirements laid down in Article 144(1)(f), Article 174(d), Article 185 and Article 188 of Regulation (EU) No 575/2013, competent authorities shall verify that those methods and procedures allow for a consistent and meaningful assessment of the performance of the internal rating and risk estimation systems, and shall verify that: (a) the validation methods and procedures are appropriate for assessing the accuracy and consistency of the rating system; (b) the validation methods and procedures are appropriate to the nature, degree of complexity and range of application of the institution’s rating systems and data availability; (c) the validation methods and procedures clearly specify the validation objectives, standards and limitations, contain a description of all validation tests, data sets, and data cleansing processes, set out data sources and reference time periods, and set the fixed targets and tolerances for defined metrics, for the initial and regular validation respectively; (d) the validation methods used, and in particular the tests performed, the reference data set used for the validation and the respective data cleansing, are applied consistently over time; (e) the validation methods include back-testing, and benchmarking as set out in Article 185(c) and Article 188(d) of Regulation (EU) No 575/2013; (f) the validation methods take account of the way business cycles and the related systematic variability in default experience are considered in the internal ratings and risk parameters, especially regarding PD estimation.