Financial institutions should be cautious against over reliance on internal models for credit risk management and regulatory capital and are urged to evaluate risk with sophisticated modelling techniques, according to a report led by global financial regulators with the Joint Forum.

The report provides insight into the current supervisory framework around credit risk, the state of credit risk management at firms and implications for the supervisory and regulatory treatments of credit risk.

In 1996, the Joint Forum was established by the Basel Committee on Banking Supervision (BCBS), the International Organization of Securities Commissions (IOSCO) and the International Association of Insurance Supervisors (IAIS) to deal with issues common to the banking, securities and insurance sectors, including the regulation of financial conglomerates.

The Joint Forum conducted a survey with supervisors and firms in the banking, securities and insurance sectors globally to understand the current state of credit risk management given the significant market and regulatory changes since the 2008 financial crisis. Fifteen supervisors and 23 firms from Europe, North America and Asia responded to the survey.

The report says supervisors should be cautious against over-reliance on internal models for credit risk management and regulatory capital. Where appropriate, simple measures could be evaluated in conjunction with sophisticated modelling to provide a more complete picture, the report says.

With the current low interest rate environment possibly generating a "search for yield" through a variety of mechanisms, supervisors should be cognizant of the growth of such risk-taking behaviours and the resulting need for firms to have appropriate risk management processes, the report adds.

Moreover, supervisors should be aware of the growing need for high-quality liquid collateral to meet margin requirements for OTC derivatives sectors, and if any issues arise in this regard they should respond appropriately.

The Joint Forum's parent committees (BCBS, IAIS and IOSCO) will consider taking appropriate steps to promote the monitoring and evaluation of the availability of such collateral in their future work while also considering the objective of reducing systemic risk and promoting central clearing through collateralisation of counterparty credit risk exposures that stems from non-centrally cleared OTC derivatives. Supervisors should consider whether firms are accurately capturing central counterparty exposures as part of their credit risk management, says the report.

"The challenges and the economic environment for credit risk management have evolved considerably in the last years. This report provides important new insights into the latest developments in credit risk management against the backdrop of a reformed regulatory framework and the emergence of new risks," says Thomas Schmitz-Lippert, chairman of the Joint Forum and executive director, International Policy at the German Federal Financial Supervisory Authority (BaFin).