RTS and GL on estimation and identification of an economic downturn in IRB modelling

Status: Under development

These draft RTS and GLs are part of the EBA’s broader work on the review of the IRB approach aimed at reducing the unjustified variability in the outcomes of internal models, while preserving the risk sensitivity of capital requirements.

  • Consultation Papers
Consultation on Guidelines for the estimation of LGD appropriate for an economic downturn (EBA-CP-2018-08)

Summary
22/05/2018

The European Banking Authority (EBA) launched today two consultations on draft regulatory technical standards (RTS) specifying an economic downturn and on a set of Guidelines related to the estimation of loss given default (LGD) appropriate for conditions of an economic downturn. The draft RTS specify the nature, severity and duration of an economic downturn, while the Guidelines focus on the appropriate estimation of the LGD in a situation of economic downturn. This package is part of the EBA’s broader work on the review of the IRB approach aiming at reducing the unjustified variability in the outcomes of internal models, while preserving the risk sensitivity of capital requirements. The consultations run until 22 June 2018.
 
Based on the feedback received in the first consultation, which took place on 1 March 2017, these draft RTS now focus solely on the identification approach. To this end, the draft RTS require institutions to consider relevant macroeconomic and credit factors when specifying the nature of an economic downturn. In particular, the severity and duration of an economic downturn should be specified taking into account the time series for the identified relevant macroeconomic and credit factors. 
 
The draft Guidelines has been developed to supplement the RTS and clarify how institutions should quantify LGD estimates appropriate for an economic downturn identified according to the draft RTS. To this end, the draft Guidelines focus on the methods institutions should use to quantify downturn LGD estimates. Several approaches are allowed and will be driven by the availability of loss data for the estimations. In situations with limited data availability, more prescriptive approaches are applied.
 
The RTS and the Guidelines together harmonise the modelling approach and, therefore, aim at creating a more level playing field across IRB institutions in this area. Specifically, the  RTS ensure that an economic downturn for comparable portfolios are subject to the same economic downturn and the Guidelines provide guidance on downturn LGD estimation taking into account the specificities of the institutions’ processes, underwriting standards and general response to adverse economic conditions. The approach followed in drafting the RTS and the Guidelines ensures the application of harmonised identification and LGD estimation methods.
 

Consultation process

 
Comments to these consultations can be sent to the EBA by clicking on the "send your comments" button on the consultation page. Please note that the deadline for the submission of comments is 22 June 2018.
 
All contributions received will be published following the close of the consultation, unless requested otherwise. A public hearing and workshop will then take place at the EBA premises on 1 June from 11:00 to 13:00 UK time. 
 

Legal basis and next steps

 
The draft RTS have been developed in accordance with Articles 181 (3)(a) and 182 (4)(a) of the Capital Requirements Regulation (CRR), which mandate the EBA to draft regulatory technical standards to specify the nature, severity and duration of an economic downturn referred to in paragraphs 181 (1)(b) and 182(1)(b).
 
The EBA has developed the draft Guidelines on its own initiative, in accordance with Article 16 of its founding Regulation, which mandates the Authority to issue guidelines and recommendations addressed to competent authorities or financial institutions with a view to establishing consistent, efficient and effective supervisory practices within the ESFS, and to ensuring the common, uniform and consistent application of Union law.
 
The draft Guidelines will be included in the EBA Guidelines on PD, LGD estimation and treatment of defaulted assets published on 20 November 2017. 
 
Second consultation on RTS on estimation and identification of an economic downturn in IRB modelling (EBA-CP-2018-07)

Summary
22/05/2018

The European Banking Authority (EBA) launched today two consultations on draft regulatory technical standards (RTS) specifying an economic downturn and on a set of Guidelines related to the estimation of loss given default (LGD) appropriate for conditions of an economic downturn. The draft RTS specify the nature, severity and duration of an economic downturn, while the Guidelines focus on the appropriate estimation of the LGD in a situation of economic downturn. This package is part of the EBA’s broader work on the review of the IRB approach aiming at reducing the unjustified variability in the outcomes of internal models, while preserving the risk sensitivity of capital requirements. The consultations run until 22 June 2018.
 
Based on the feedback received in the first consultation, which took place on 1 March 2017, these draft RTS now focus solely on the identification approach. To this end, the draft RTS require institutions to consider relevant macroeconomic and credit factors when specifying the nature of an economic downturn. In particular, the severity and duration of an economic downturn should be specified taking into account the time series for the identified relevant macroeconomic and credit factors. 
 
The draft Guidelines has been developed to supplement the RTS and clarify how institutions should quantify LGD estimates appropriate for an economic downturn identified according to the draft RTS. To this end, the draft Guidelines focus on the methods institutions should use to quantify downturn LGD estimates. Several approaches are allowed and will be driven by the availability of loss data for the estimations. In situations with limited data availability, more prescriptive approaches are applied.
 
The RTS and the Guidelines together harmonise the modelling approach and, therefore, aim at creating a more level playing field across IRB institutions in this area. Specifically, the  RTS ensure that an economic downturn for comparable portfolios are subject to the same economic downturn and the Guidelines provide guidance on downturn LGD estimation taking into account the specificities of the institutions’ processes, underwriting standards and general response to adverse economic conditions. The approach followed in drafting the RTS and the Guidelines ensures the application of harmonised identification and LGD estimation methods.
 

Consultation process

 
Comments to these consultations can be sent to the EBA by clicking on the "send your comments" button on the consultation page. Please note that the deadline for the submission of comments is 22 June 2018.
 
All contributions received will be published following the close of the consultation, unless requested otherwise. A public hearing and workshop will then take place at the EBA premises on 1 June from 11:00 to 13:00 UK time
 

Legal basis and next steps

 
The draft RTS have been developed in accordance with Articles 181 (3)(a) and 182 (4)(a) of the Capital Requirements Regulation (CRR), which mandate the EBA to draft regulatory technical standards to specify the nature, severity and duration of an economic downturn referred to in paragraphs 181 (1)(b) and 182(1)(b).
 
The EBA has developed the draft Guidelines on its own initiative, in accordance with Article 16 of its founding Regulation, which mandates the Authority to issue guidelines and recommendations addressed to competent authorities or financial institutions with a view to establishing consistent, efficient and effective supervisory practices within the ESFS, and to ensuring the common, uniform and consistent application of Union law.
 
The draft Guidelines will be included in the EBA Guidelines on PD, LGD estimation and treatment of defaulted assets published on 20 November 2017. 
 
Consultation on RTS on the specification of the nature, severity and duration of an economic downturn (EBA/CP/2017/02)

Summary
01/03/2017

The European Banking Authority (EBA) launched today a public consultation on its draft Regulatory Technical Standards (RTS) specifying the nature, severity and duration of an economic downturn according to which institutions shall estimate the downturn loss given default (LGD) and conversion factor (CF). These draft RTS are part of the EBA’s broader work on the review of the IRB approach aimed at reducing the unjustified variability in the outcomes of internal models, while preserving the risk sensitivity of capital requirements. The consultation runs until 29 May 2017.

In particular, these draft RTS specify the three conditions - nature, severity and duration - of an economic downturn and propose a methodological approach to identify them. This approach assumes that downturn economic conditions are driven by macroeconomic and credit factors and should be analysed at the level of model components. 
 
In line with the mandate laid down in the Capital Requirements Regulation (CRR), these draft RTS specify a methodological approach to identify the economic downturn conditions, but they do not cover the methods used by institutions to reflect such conditions into downturn LGD and CF estimates. The consultation paper is, therefore, proposing in a separate section a method to be used regarding the LGD parameter as a proposed amendment to the downturn adjustment section of the Guidelines on PD and LGD estimation and the treatment of defaulted assets.
 
Given the relatively high degree of prescriptiveness of the proposed model component approach, which is likely to require substantial resources both from institutions and supervisors when it comes to its implementation, the EBA is also seeking feedback on two simpler alternative approaches to formulate supervisory expectations towards downturn LGD estimation, namely the reference value approach and the supervisory add-on approach. 
Considering the material changes that these RTS may require to numerous rating systems currently used by institutions especially for the modelling of downturn LGD and CF, the EBA is proposing to implement these standards by end-2020. This deadline refers to the implementation of all changes stemming from the regulatory review of the IRB approach.

Consultation process

Comments to this consultation can be sent to the EBA by clicking on the "send your comments" button on the consultation page. Please note that the deadline for the submission of comments is 29 May 2017.
All contributions received will be published following the close of the consultation, unless requested otherwise. A public hearing will then take place at the EBA premises on 4 April 2017 from 14:00 to 16:00 UK time.

Legal basis and next steps

These draft RTS have been developed according to Articles 181(3)(a) and 182(4)(a) of the CRR, which mandate the EBA to specify the nature, severity and duration of an economic downturn  according to which institutions shall estimate the downturn LGD and CF.