Response to consultation on Regulatory Technical Standards on the allocation of off-balance sheet items and UCC considerations
Question 1. Do you have any comment on the non-exhaustive list of examples provided?
The classification of the contingent liability for chargebacks into an off-balance sheet item with 50% conversion fator for credit risk is not in alignment with the stated objective of the RTS to “ensure that those commitments are classified according to their true risk characteristics”.
From a risk perspective, there are two main reasons why the proposed treatment does not promote classification to true risk characteristics, but actually promotes the contrary;
a. The actual loss risk is remote, not even near to the proposed 50% conversion factor
b. The automatic capitalization of this risk type under pillar 1 standardized is not needed and a poor fit within the prudential framework
a. In line with accounting regulation (IAS37), chargeback commitments are currently not recognized in the financial statements because of the level of unlikeliness of the risk materializing. This is because of the double contingency underlying chargeback risk. First, a shopper induced chargeback must occur which is not related to any credit risk. Second, there should not be any payment volume in process for this merchant from which the institution can recoup this chargeback. This situation could arise due to default of the merchant but does not have to. It can for example also be because of switching of payment processer by the merchant.
The de-recognition under IAS 37 is prescribed “because settlement is not probable”. The institution will have the actual realized losses to evidence this derecognition to the accountant. Whereas this contingent liability has to be derecognized under accounting regulation because of low likelihood, the prudential regulation applies a high 50% conversion factor.
To exemplify; for our institution the realized chargeback losses for all years in the period 2017-2022 are smaller than 0.02% of processed volumes (for which the consultation paper stated “commitment” applies). In short, the 50% factor looks unrealistic. Previous comments from BaFIN from 2022 as part of QA also echo this message, same for the answer to question id 2016_2916 by EBA.
Additionally, this now proposed 50% conversion factor is not in any way substantiated in the consultation document.
b. The reality of a chargeback materializing is contingent on a non-credit risk related event (shopper not happy with service delivered) and furthermore highly dependent on the (operational) risk mitigating measures put in place by the institution. It is for example, very common for merchants to be required to hold reserve balances at processing institutions that act as additional risk mitigation for chargebacks. Or for institutions to introduce extensive monitoring that allows for quick mitigating action. The double contingent nature, combined with the highly operational options that specific institutions can apply, makes capitalizing under a standardized method an ill fit. If additional regulatory capital is deemed necessary, the supervisor currently has the option to apply a mandatory pillar 2 add-on for this, taking into account how the risk is mitigated in practice by the specific institution – and could even be classified under the operational risk category.
Finally, from a macro perspective, this proposed approach is not business-model neutral as it does not reflect true risk well. It could therefore also create an incentive for non-bank firms to pursue a strategy of non-supervision – outside the SSM – further destabilizing the aspired level-playing-field for regulation in the financial industry.