Human Judgement

Definition

Human judgement is used in the assignment of exposures to the grades or pools of a risk model

Institutions may use human judgement in the application of risk model in the following cases:

• in the application of the qualitative variables used within the model;
• via overrides of the inputs of the rating assignment process;
• via overrides of the outputs of the rating assignment process.

Governance Requirements

The use of human judgement in credit systems requires that there is a framework in place that establishes clear and detailed guidelines and procedures on the application of human judgement (e.g. through the use of pre-defined questionnaires).

The use of human judgement should be documented in a way that ensures the rating assignment can be understood and replicated by a third party.

Institutions should specify clear criteria for the use of qualitative model inputs and they should ensure a consistent application of such inputs by all relevant personnel and a consistent assignment of obligors or facilities posing similar risk to the same grade or pool as required by Article 171(1)(a) of Regulation (EU) No 575/2013.

For the purpose of Article 172(3) of Regulation (EU) No 575/2013 institutions should specify the policies and criteria for the use of overrides in the rating assignment process. These policies should refer both to possible overrides of inputs and outputs of such process and should be specified in a conservative manner such that the scale of conservative overrides should not be limited. In contrast, the scale of potential decreases of the estimates resulting from the model, either by overriding the inputs or outputs of the rating assignment process, should be limited. In applying the overrides institutions should take into account all relevant and up-to-date information.

Institutions should document the scale and rationale of each override. Wherever possible institutions should specify a predefined list of possible justifications of the overrides to choose from. Institutions should also store information on the date of override and the person that performed and approved it.

Institutions should regularly monitor the level and justifications for overrides of inputs and outputs of the rating assignment process. They should specify in their policies the maximum acceptable rate of overrides for each model. Where those maximum levels are breached, adequate measures should be taken by the institution. The rates of overrides should be specified and monitored at the level of calibration segment. Where there is a high number of overrides institutions should adopt adequate measures to improve the model.

Institutions should regularly analyse the performance of exposures in relation to which an override of input or output of the rating assignment process has been performed in accordance with Article 172(3) of Regulation (EU) No 575/2013.

Institutions should regularly assess the performance of the model before and after the overrides of outputs of the rating assignment process. Where the assessment concludes that the use of overrides significantly decreased the model’s capacity to accurately quantify the risk parameters (‘predictive power of the model’), institutions should adopt adequate measures to ensure the correct application of overrides.

When human judgement is used for the purpose of risk differentiation, for example in the setting of the model’s assumptions, the identification of risk drivers and determination of their weights, or the identification and combination of model components, there is a risk of the model-based assignments being inaccurate. To mitigate this risk, institutions should ensure that the incorporation of human judgement is appropriately managed and proportionate to the number of available observations

The results of the statistical model must be complemented by human judgement, especially by taking into account all information not included in the model. The higher the number of relevant observations, the more the institutions should rely on the outcomes of the statistical model.

For the purposes of quantifying the risk parameters to be associated to grades or pools, estimates must not be based purely on judgemental considerations.To this end, where human judgement is used to a greater extent because of the ow number of available internal observations, institutions should apply a higher MoC to their estimates to account for additional uncertainty.

In addition, whenever human judgement is used in the estimation of risk parameters (for either risk differentiation or risk quantification purposes) institutions are expected to have in place a framework under paragraph 35 of the EBA GL on PD and LGD.

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