21 March 2022
The European Banking Authority (EBA) published today its final draft Regulatory Technical Standards (RTS) on probabilities of default (PDs) and losses given default (LGDs) for default risk model for institutions using the new Internal Model Approach (IMA) under the Fundamental Review of the Trading Book (FRTB). These final draft RTS specify the requirements for estimating PDs and LGDs using an institution's internal methodology or external sources. These draft RTS are part of the deliverables included in the roadmap for the new market and counterparty credit risk approaches.
Institutions using the IMA to compute own funds requirements for market risk are required to compute additional own funds requirement using an internal default risk model for their positions in traded debt and equity instruments included in IMA trading desks.
These draft RTS clarify the requirements to be met for estimating PDs and LGDs under the default risk model. The draft RTS specify that an internal methodology used to calculate PDs and LGDs under the default risk model should meet all requirements applicable to the corresponding Internal ratings‐based (IRB) approach. In addition, the draft RTS include the possibility for institutions to produce conservative ‘fallback’ PD and LGD values to be used only where needed. Finally, these RTS specify the requirements that external sources are to fulfil for their use under the default risk model, ensuring that the methodology employed to derive the PDs and LGDs from these sources is conceptually sound.
These draft RTS have been developed according to Article 325bp(12) of Regulation (EU) No 575/2013 (Capital Requirements Regulation – CRR), which mandates the EBA to “specify the requirements that an institution's internal methodology or external sources are to fulfil for estimating default probabilities and losses given default in accordance with point (e) of Article 325bp(5) and point (d) of Article 325bp(6)”.