Question ID
2017_3554
Legal act
Regulation (EU) No 575/2013 (CRR)
Topic
Credit risk
Article
164
Paragraph
4
COM Delegated or Implementing Acts/RTS/ITS/GLs/Recommendations
Not applicable
Article/Paragraph
None
Name of institution / submitter
The Danish Financial Supervisory Authority
Country of incorporation / residence
Denmark
Type of submitter
Competent authority
Subject matter
10 % LGD floor for retail exposures secured by residential property
Question

How should an institution, which uses the IRB approach calculate the 10 % LGD floor mentioned in Article 164(4) CRR in the case where a part of the individual exposures are guaranteed by a guarantor (institution) which is treated under the Standardised Approach?

Background on the question

We deem that it is currently not clear whether the substitution approach is allowed in case of IRB exposures guaranteed by a guarantor that is treated under the Standardised Approach, i.e. is it allowed to use the guarantor’s risk weight from the Standardised Approach for the guaranteed part of the exposure.

Assuming that the substitution approach is allowed we are interested in knowing if the approach described below complies with the requirement in Article 164(4) CRR, which states that the exposure weighted average LGD for all retail exposures secured by residential property and not benefitting from guarantees from central governments shall not be lower than 10 %.

In particular, considering that an institution uses the following approach to make sure that the 10 % requirement is fulfilled:

1. If the exposure weighted LGD average for the portfolio of retail exposures secured by residential property is less than 10 % the institution scales all LGD estimates such that an LGD average of 10 % is obtained.

2. If there is a guarantee from an institution, the guaranteed part is deducted from the ”Original Exposure” in order to determine the ”Exposure Value” (EAD).

3. The guaranteed part is substituted to the Standardised Approach and risk weighted as exposures to institutions.

4. RWEA for the remaining part of the exposure (EAD) is calculated using the calculated (marginal) LGD from point 2 (the LGD for the unguaranteed exposures).

This approach leads to an LGD average of 9.7% for the part of the exposures remaining under the IRB approach when the LGD’s are weighted with ”Exposure Value” (EAD), i.e. after the guaranteed part is substituted to the Standardised Approach. If the LGD’s instead are weighted with the “Original Exposure” the LGD average will be 10%.

If this approach is allowed, the institution in our opinion indirectly gets a benefit from the guarantee as it only uses an exposure weighted average LGD of 9.7 % for the exposures remaining under the IRB approach after substitution. This would however not comply with Article 164 (4), which provides an exception  only for institutions benefiting from guarantees from central governments.

Submission date
Final publishing date
Final answer

In accordance with article 164(4) of Regulation (EU) No 575/2013 as amended by Regulation (EU) 2019/876 – CRR2, the exposure weighted average LGD for all retail exposures secured by residential property and not benefiting from guarantees from central governments shall not be lower than 10 % and the exposure weighted average LGD for all retail exposures secured by commercial immovable property and not benefiting from guarantees from central governments shall not be lower than 15 %.

 

Therefore, in the case of an additional unfunded credit protection (UFCP), the calculation of the weighted average LGD to be compared with the floors depends on the nature of the guarantee and the methodology used to account for the UFCP.

 

  1. The modelling approach is understood as the adjustment of grades, pools or LGD estimates, including LGD in-default and ELBE, by considering the UFCP in the estimation of risk parameters as further specified in the Guidelines on Credit risk mitigation for institutions applying the IRB Approach with own estimates of LGDs (GL on CRM hereafter).
  2. The override is understood as the adjustment of grades, pools or LGD estimates, including LGD in-default and ELBE, in the application of risk parameters via override of the grade assignment process in accordance with Article 172(3) of Regulation (EU) No 575/2013 and Section 8.2 of the EBA GL on PD and LGD estimation
  3. The double default treatment is understood as the calculation of the risk-weighted exposure amount in accordance with Articles 153(3), 154(2), 161(4) and 164(3), of Regulation (EU) No 575/2013
  4. The substitution of risk parameters approach is understood as the substitution of both the PD and LGD risk parameters of the underlying exposure with the corresponding PD and LGD of a comparable direct exposure to the guarantor as further specified in the GL on CRM when comparable direct exposures to the guarantor are, or would be, treated under the IRB approach with or without own estimates of LGD and conversion factors,
  5. The substitution of risk weight approach is understood in the GL on CRM as the use of the risk weight applicable under the Standardised Approach in accordance with Article 183(4) of Regulation (EU) No 575/2013, when the institution applies the Standardised Approach for comparable direct exposures to the guarantor, and does not recognise the credit risk mitigation effects of the UFCP in the PD and LGD estimates in accordance with the modelling approach.

 

In the case of the use of the substitution of risk weight approach, the relevant LGD floor applies only to the part of the exposure, if any, not benefiting from the guarantee . Consequently, the exposure value of the non-guaranteed part should be used as the weight to account for the LGD of the original exposure in the exposure weighted average of the LGD.

 

In the case the substitution of risk parameters approach is used to recognise the effect of the UFCP, then:

 

  • In the case the UFCP is a guarantee from central governments, the LGD of the guaranteed part of the exposure should not be used for the calculation of the exposure weighted average LGD. In other words, the relevant LGD floor applies only to the part of the exposure, if any, not benefiting from the guarantee; and only this non-guaranteed part of the exposure should be used as the weight to account for the LGD of the original exposure in the exposure weighted average of the LGD.
  • In the case the UFCP is not a guarantee from central governments, the exposure value of the guaranteed part of the exposure should be used as the weight for the LGD of direct comparable exposure to the guarantor and the exposure value of the non-guaranteed part should be used as the weight to account for the LGD of the original exposure.

 

In the case neither the substitution of risk weight nor the substitution of risk parameters approach are used to recognise the effect of the UFCP, then:

 

  • In the case the UFCP is a guarantee from central governments, the LGD of the exposure should not be used for the calculation of the exposure weighted average LGD.
  • In the case the UFCP is not a guarantee from central governments, the LGD of the exposure should be used for the calculation of the exposure weighted average LGD, and the total exposure value should be used as a weight.
Status
Final Q&A
Answer prepared by
Answer prepared by the EBA.

Disclaimer

The Q&A refers to the provisions in force on the day of their publication. The EBA does not systematically review published Q&As following the amendment of legislative acts. Users of the Q&A tool should therefore check the date of publication of the Q&A and whether the provisions referred to in the answer remain the same.