The criteria for supervisory recognition of banks' modelling of specific risk require that a bank's model must capture all material components of price risk⁸¹ and be responsive to changes in market conditions and compositions of portfolios. In particular, the model must:

In addition, the bank must be able to demonstrate that it has methodologies in place which allow it to adequately capture event and default risk for its traded debt and equity positions.

⁸¹ Banks need not capture default and migration risks for positions subject to the incremental risk capital charge referred to in Paragraphs CA-14.11.7 and CA-14.11.8.

⁸² The key measurement of model quality are "goodness-of-fit" measures which address the question of how much of the historical variation in price value is explained by the model. One measure of this type which can often be used is an R-squared measure from regression methodology. If this measure is to be used, the bank's model would be expected to be able to explain a high percentage, such as 90%, of the historical price variation or to explicitly include estimates of the residual variability not captured in the factors included in this regression. For some types of model, it may not be feasible to calculate a goodness-of-fit measure. In such an instance, a bank is expected to contact the CBB to define an acceptable alternative measure which would meet this regulatory objective.

⁸³ The bank should be expected to demonstrate that the model is sensitive to changes in portfolio construction and that higher capital charges are attracted for portfolios that have increasing concentrations.

⁸⁴ The bank should be able to demonstrate that the model will signal rising risk in an adverse environment. This could be achieved by incorporating in the historical estimation period of the model at least one full credit cycle and ensuring that the model would not have been inaccurate in model at least one full the downward portion of the cycle. Another approach for demonstrating this is through simulation of historical or plausible worst-case environments.

⁸⁵ Banks should be able to demonstrate that the model is sensitive to material idiosyncratic differences between similar but not identical positions, for example debt positions with different levels of subordination, maturity mismatches, or credit derivatives with different default events.

⁸⁶ For equity positions, events that are reflected in large changes or jumps in prices must be captured, e.g. merger break-ups/takeovers. In particular, firms must consider issues related to survivorship bias.

⁸⁷ Aimed at assessing whether specific risk, as well as general market risk, is being captured adequately.