Response to consultation paper amending Guidelines on definition of default
1. Question 1: Do you believe the current guidelines result in some exposures under forbear-ance measures to be incorrectly classified as defaults, thus hindering proactive, preventive and meaningful restructurings given the detrimental effects that defaulted status has for the affected obligors? If so, please further specify the characteristics of the exposures, which you deem as being subject to an incorrect classification of default.
The EBF is of the view that the current guidelines may, in certain cases, impede proactive, preventive, and meaningful debt restructuring. This is primarily due to the rigid application of the 1% Net Present Value (NPV) loss threshold under the Diminished Financial Obligation (DFO) criterion, which can lead to exposures subject to forbearance measures being incorrectly classified as defaulted. Such automatic classification discourages institutions from offering restructuring solutions that could otherwise support borrowers experiencing temporary financial difficulty, help them avoid the severe consequences of a default status, and at the same time increase the likelihood of full repayment to the bank.
The EBA argues that the flexibility already embedded in the current framework is sufficient and therefore proposes no substantive amendments. However, this conclusion is not supported by any rigorous cost/benefit analysis assessing the economic impact on clients or potential implications for financial stability. In practice, the strict automaticity of the 1% Net Present Value (NPV) loss threshold under the Diminished Financial Obligation (DFO) criterion often jeopardizes the flexibility the framework purports to offer. It results in exposures being classified as defaulted even when the client’s financial distress is temporary, the probability of full repayment remains high, and the forbearance measure is designed precisely to restore solvency and avoid default.
Unlike the accounting framework, which is principle-based and does not prescribe a specific threshold for NPV loss, the prudential treatment is overly prescriptive. Under accounting standards, assessments of significant increases in credit risk (SICR) and impairment are conducted using reasonable and supportable information without undue cost or effort. Aligning the prudential approach more closely with this principle-based methodology would allow institutions to exercise informed judgement while still ensuring that impairment and credit risk assessments remain robust.
Moreover, the discretionary classification of an exposure as “forborne” provides little practical flexibility in relation to the DFO for exposures already designated as such. The heart of the issue; and the justification for amending the Guidelines, lies in granting institutions sufficient discretion to support borrowers whose difficulties are temporary and can be resolved through meaningful restructuring. Such flexibility would (a) allow the debtor to avoid the consequences of a default classification and (b) increase the probability of full repayment for the bank.
The current 1% NPV threshold, which was intended as a backstop to ensure proper default classification, now unduly constrains restructuring measures that could otherwise achieve these objectives. An upward re-calibration of this threshold would be fully consistent with the EBA’s mandate to introduce greater flexibility. It would enable banks to extend forbearance while maintaining exposures in performing status, thus avoiding default classifications that impede restructuring. Incorrect default classification occurs frequently in periods of high interest rates, where the application of forbearance measures is a standard practice to preserve the obligor’s financial solvency and promote an improved payment behavior. The current 1% diminished financial obligation (DFO) threshold that leads to a situation of default is very penalizing, especially in emerging countries with high interest rates. The 1% threshold means having to classify exposures as defaulted when such is not the case. This prevents banks from engaging in forbearance measures with regards to viable loans, and in the case of emerging markets it prevents them from competing with local peers. The mere application of a threshold that (i) is ‘non-sensitive’ to market practices; (ii) disregards the institution’s risk profile or (iii) does not consider the portfolio characteristics, should not be the sole criterion to classify forbearance exposure in default. Furthermore, this criterion for the Diminished Financial Obligation (DFO) is very sensitive to the new conditions granted to the customer, and it could lead to breaching this threshold and automatically record the facility as defaulted, even if the customer is performing and the loan or credit is profitable for the bank. The threshold also fails to account for the institution’s risk profile or the specific characteristics of the exposure, resulting in a “one-size-fits-all” approach that is insensitive to differing portfolio realities. Nevertheless, the DFO rule constitutes only a limited component within the comprehensive regulatory framework on credit risk management, loan monitoring, treatment of forborne exposures, and the identification and management of non-performing exposures. Prior to the introduction of the DFO threshold, the existing criteria aligned with current regulation, namely, the assessment of the facility/obligor status prior to the granting of forbearance and the evaluation of the characteristics of the revised terms, already provided a sufficient basis to distinguish between performing and non-performing forbearance at the time of concession. Adjusting the NPV threshold would leave the remainder of this framework intact.
The EBF therefore believes that the delta NPV threshold should be recalibrated to provide greater flexibility, with an upward adjustment cap; for example, to 5%, being an appropriate and proportionate solution. A higher threshold would act as a backstop rather than a rigid rule, allowing default classification to occur when there are genuine indicators of unlikeliness to pay, while avoiding the automatic classification of exposures where repayment remains likely. Moreover, there is no evidence to suggest that raising the threshold would pose a threat to financial stability, particularly as the number of exposures affected is expected to be limited. Any modification of the threshold made by the EBA should be done in such a way that the NPV threshold is set by the bank under a certain cap (e.g. 5%). Thus, banks remain compliant if their current framework has a 1% threshold and have room for manoeuvre in a longer-term reflection for better default identification if they choose to increase their threshold under the range, and up to the 5% cap.
It is also important to note that the factors influencing delta NPV, such as residual maturity and the original interest rate, are not necessarily related to the borrower’s financial condition. A more flexible threshold would allow banks to consider these variables without penalizing otherwise viable borrowers. In addition, the current 1% threshold can conflict with national legal frameworks. For instance, in Italy, the prohibition on compounding interest (“Anatocismo”) can lead to a breach of the threshold even in cases involving a simple deferral of payments. Such inconsistencies highlight the inadequacy of the current approach.
Importantly, introducing greater flexibility in default classification does not create any scope for concealing losses. Under accounting standards, any loss associated with a forbearance measure is recognised in the bank’s profit and loss statement at the time the concession is granted. Furthermore, the heightened credit risk of the exposure is adequately captured, as the granting of forbearance typically results in a Stage 2 classification under IFRS 9 and a corresponding increase in provisioning. However, the rigidity of the current 1% threshold introduces a structural inconsistency: exposures may be required to be classified as defaulted for prudential purposes, while remaining in Stage 2 (not impaired) under the principle-based accounting framework. This misalignment undermines coherence between prudential and accounting treatments for banks that practice this approach and highlights the need for a more flexible approach.
Notably, the consultation paper does not present any evidence that raising the delta NPV threshold would pose a threat to financial stability. The number of exposures likely to benefit from such a measure is limited. Conversely, the detrimental consequences for obligors of being classified as defaulted, such as increased cost of credit due to capital requirements and contagion effects on connected clients, are acknowledged but not adequately considered in the EBA’s conclusion that the current threshold is “proportionate”.
It is also pertinent to recall that Article 178 CRR defines a diminished financial obligation as a “material forgiveness or postponement” of principal, interest, or fees. The current fixed threshold risks diverging from this principle of materiality. It would therefore be more appropriate for the delta NPV threshold to be assessed in light of materiality, either by increasing it; for example, to 5%, or by reframing it as an indicative measure rather than a hard rule.
Before the introduction of the DFO threshold, institutions relied on existing criteria, such as the assessment of the facilities or obligor’s status prior to granting forbearance and the evaluation of revised contractual terms, to distinguish between performing and non-performing exposures. These criteria, reflective of each institution’s risk profile and strategic orientation, were effective and subject to supervisory scrutiny, including on-site inspections. They remain so today and support continuous improvement in internal governance and policies.
In conclusion, the EBF considers the current application of the DFO criterion to be overly rigid, frequently leading to the misclassification of exposures as defaulted in cases of temporary financial difficulty. Adjusting the delta NPV threshold to a more appropriate level or assessing it against the principle of materiality by reframing it as an indicative measure rather than a hard rule, would transform it from an overriding determinant of default status into a backstop complementing other forbearance criteria. Such a change would enable banks to provide meaningful support to viable borrowers, align prudential and accounting frameworks, and fulfil the legislative mandate to encourage proactive, preventive, and meaningful debt restructuring.
2. Question 2: Do you think that relaxing the criteria for the minimum period before returning to the non-defaulted status for defaulted forborne exposures could be an appropriate measure to alleviate a higher burden on your institution and clients? How material would the difference be in your case between the amounts of forborne exposures classified as NPE and as defaulted if the minimum one-year probation period in the definition of default were reduced to three-months for certain forborne exposures (with change in NPV below 5% and no loss on the nominal amount)? Would that proposal create additional operational burden or practical impediments? Do you see support such proposal, and if so, for which reasons?
Regarding DoD framework, operational issues are of utter importance for banks such as the impact on ratings systems generating model changes, or the connection with other concepts such as NPE. This is why banks favour alignment between NPE – default in the first place. Banks have made significant efforts throughout the years to align NPE and default definitions and considers that such alignment provides optimal framework. Any changes to the regulatory framework should be weighted with the possible operational implications for banks (e.g. material model changes).
We do not anticipate that the impact of the proposed EBA alternative measures (reduction of probation period, alternative definition of material payment) under their current form would be significant as the conditions would target few forborne measures. In current EBA proposals, the operational burden of the alternative measures would outweigh the potential benefit. Indeed, operational implementation implies the storage of detailed information regarding the forbearance measures and NPV test results which would be heavy to handle in comparison with the possible low number of facilities / obligors concerned by the measures:
- Applying an alternative probation period exclusively to certain types of forbearance could result in an IT complexification as it would require having a very detailed view of the forbearance stored in a database
- The results of the NPV test verification should be stored for each of the concerned forbearance measure, while the NPV test can be performed in less automated way
In addition, the alternative material payment definition proposed by the EBA will not solve possible issues encountered in corporate restructuring for bullet loans.
Before EBA endorses any proposals, which could imply potential NPE-default misalignment, such proposals should be reflected in prudential regulation from a holistic point of view, by amending conjointly the level 1 text (NPE definition in CRR) in order to avoid such potential misalignment. In any case, proposals should be built in a such a way that they provide reasonable benefits compared to the costs (e.g. enlarging conditions so that the targeted scope is material).
We encourage the EBA to finalise as soon as possible its updates on the RTS for assessing the materiality of extensions and changes of the IRB approach where the objective is to alleviate the materiality of certain changes to the definition of default. In addition, if EBA introduces greater flexibility to DoD framework, we support the EBA providing at the same time solutions to ease the implementation regarding impact on rating systems. Among various solutions, one pragmatic possibility is the intermediate trajectory in which default rules would be modified (thus reducing volumes to be processed) without a mandatory immediate review of the model calibrations requiring retropolation of definition of default in historical defaults for modelling data. Models could be reviewed at their normal pace, naturally integrating over time defaults according to the new rules, as long as calibration level of final risk parameters remain sufficient to cover the inherent risk of the covered exposures. This will ensure reasonable operational impacts as well as a relative stability of the risk parameter framework by avoiding unwelcome volatility of capital requirements.
In a longer-term reflection, we take the opportunity to provide below an illustration of issues spotted in current regulation which may need greater flexibility. Whenever needed, such reflection for better identification of default will need longer term discussion which involves other deciders such as legislators, in order to ensure consistency between different regulations / texts from a broader perspective.
These issues concern:
- Relaxing the criteria for the minimum probation period (reduction of the probation period) for forborne exposures before returning to the non-defaulted status could be appropriate to support corporates when financial difficulties are behind them and when their credit profile has returned to an acceptable level allowing a normalized course of business and access to debt markets
Providing flexibility in current mandatory repayment conditions for exiting default under justifiable conditions (e.g. bullet loans or restructuring in bullet)
The EBF does not support the proposed reduction of the probation period, as it would impose significant operational, risk management, and reporting burdens particularly for IRB banks without delivering clear benefits to banks or clients. The proposal introduces unnecessary complexity by applying distinct treatments to forborne exposures and relies solely on the size of losses rather than the borrower’s potential for sustainable repayment. It also risks regulatory inconsistency by diverging from CRR and ECB supervisory expectations (as seen in the ECB guide to internal models (EGIM) – Chapter Credit Risk, Section 12 – Return to non-defaulted status, paragraph 172(b)), and any shortening of the probation period should only be considered if aligned with a reduced cure period under EU Regulation 575/2013. Given the strict conditions for eligibility and the limited practical impact, the proposal is not seen as an adequate or proportionate solution to the misclassification of defaults. A more balanced and comprehensive approach is needed to address the underlying challenges without undermining the coherence of the prudential framework.
3. Question 3: Do you see any alternatives other than those referred to in this section that the EBA should consider under Article 178(7) CRR to update the Guidelines and encourage insti-tutions to engage in proactive, preventive and meaningful debt restructuring to support ob-ligors?
EBF considers that a higher NPV threshold would encourage institutions to engage in proactive, preventative, and meaningful debt restructuring to support obligors. Alternatively, the 1% threshold could be used as an indicator of a diminished financial obligation rather than as a hard criterion. This approach would provide banks with greater flexibility to determine the DFO based on the characteristics of each exposure.
Among other things, raising the threshold in paragraph 51 of the GL DoD was identified by the industry as the better option to achieve flexibility while minimising the operational impact, for at least two main reasons:
- The threshold is applied at the bottom of the process, so its change would only affect the classification of the positions actually involved. While other possible changes intervening at an earlier stage of the assessment (like changes in the definition of forbearance or in the metric for the calculation of delta NPV) would affect all portfolios and imply more demanding interventions.
- The GL define the threshold as a cap to the level of delta NPV that each bank shall set in its internal policies (Paragraph 51 of the GL: Institutions should set a threshold for the diminished financial obligation that is considered to be caused by material forgiveness or postponement of principal, interest, or fees, and which should be calculated according to the following formula, and should not be higher than 1% […]). This means that if a bank, in light of its own credit policies and local practices on forbearance measures, or for any other reasons, does not consider it necessary to make use of the additional flexibility provided by a higher EBA threshold, it can simply leave the threshold unchanged in its own internal policies and no implementation will be needed.
4. Question 4: Do you use internal definitions of default and NPE that are different from each other? Which differences are these and how material are those differences? Do you have any reasons or observed practical impediment that warrants a different definition of NPE and default? If so, please provide examples where a different definition of NPE and default is appropriate.
In line with the supervisory expectation as widely acknowledged and enforced, general practice is to align the definitions of default and NPE. The EBA’s current proposal conflicts with that alignment by creating distinct treatments of the return to performing/non-default status. Hence, we do not support a treatment that causes differences.
5. Question 5: Would a potential lack of alignment between the default and NPE definition lead to issues in accounting in your case?
There is no misalignment between definition of default and NPE. There is potentially a misalignment between definition of default and Stage 3 classification, which depends on the bank’s practice. There is no regulatory obligation to fully align default and IFRS 9 Stage 3 definitions. Some banks align them voluntarily for operational simplicity, but divergence is legitimate and acknowledged by regulators.
Even before the need to adapt banks’ systems and policies, a legal assessment would be needed to identify in which cases reference should be made to each of the two definitions (and to adapt the policies and processes accordingly). In addition to implementation costs, the recurring burden of keeping two categories, very similar but not identical, instead of one, shall be considered.
Additionally, it remains hard to grasp the added value of meaningful debt restructuring if only the default definition will be adjusted while leaving the NPE definition untouched. It is exactly those NPEs that will be used in the NPE strategy and play a pivotal rule through their direct impact on capital.
6. Question 6: Do you agree that no specific provisions should be introduced for moratoria on the grounds of the sufficient flexibility of the revised framework? In case you think the pro-posed alternative treatment for legislative moratoria should be included in these guidelines, do you have any evidence of the definition of default framework being too procyclical in the context of moratoria? Do you agree with the four conditions that need to be satisfied?
In EBF’s view, the Guidelines should provide specific provisions for moratoria, i.e. general forbearance measures granted in the occasion of emergencies, such as the Covid pandemic, floods or earthquakes, to help household and businesses face the consequences of such events. In these cases, financial support measures such as the postponement of loan installments might be decided by public authorities or offered by banks to all clients in the affected areas, in order to allow them to devote all available resources to recovery and preserve as much as possible of the economic fabric.
EBF considers the existing default framework does not display a significant degree of procyclicality, in the context of moratoria, as institutions are effectively applying established measures and methodologies to address and limit such impacts. Nevertheless, the establishment of a specific regulatory treatment for legislative moratoria is regarded as a constructive step, as it strengthens certainty and consistency by codifying into the framework what has already been applied in practice.
The EBF support’s the introduction of a derogation for moratoria such that they do not lead to a reclassification under the forbearance status, as envisaged in the “alternative approach” outlined in the consultation box.
As regards to the condition that the moratoria shall be accompanied by fiscal measures adopted by the respective Member State, EBF’s does not support the fourth criteria identified by the EBA, which refers to the condition that the moratoria shall be accompanied by fiscal measures adopted by the respective Member State. However, if the condition remains a more flexible approach, it is deemed appropriate. The requirement to accompany moratoria with Member State fiscal measures is too restrictive, as scope/definition of such measures is unclear and their approval may lag the moratoria, creating uncertainty for banks and clients.
EBF considers the first condition should be broadened to cover in addition to the payment schedule, those cases where the moratoria include a cap to the interest rates.
In addition, the EBF recommends that the derogation be extended to cover non-legislative moratoria that is: (i) agreed or coordinated at the industry or sector level (e.g. through banking associations, enterprises, or consumer associations); (ii) encouraged or supported by public authorities, including local governments or agencies. Such initial measures complement legislative measures and can be implemented more swiftly to support households and businesses during emergencies, if the conditions envisaged for legislative moratoria are met.
Regarding the conditions for legislative moratoria to benefit from the treatment underlined by EBA, we think that such conditions should align with the ones specified in legal texts detailing the moratoria (in particular regarding the fact that the moratorium does not apply to new loans granted after the date when the moratorium was announced).
7. Question 7. Do you agree with the revised treatment of technical past due situations in rela-tion to non-recourse factoring arrangements? And if you do not agree, what are the rea-sons? Do you have any comments on the clarifications of paragraphs 31 and 32 in the current GL DoD?
EBF agrees with the proposed changes such as increasing the exceptional treatment of days past due at invoice level from 30 to 90 for factoring arrangements. These that are intended to address an important concern raised by the industry. The treatment of technical past-due situations under non-recourse factoring agreements demonstrates greater alignment with the inherent payment flexibility typically associated with this type of product, while duly reflecting the concerns expressed by the industry over recent years.
Specific treatment for operational lease exposures:
As expressed in the Guidelines, EBA also considered to extend the exception for factoring to leasing arrangements, but the EBA deemed in the first place that the dunning process is under full control of the leasing institution such that late payments should be addressed (pre-emptively) by the leasing institution in order to prevent default classifications. However, operational lease arrangements share many similarities with factoring arrangements which justify reconsidering extension of the specific treatment for factoring arrangements to operational lease.
8. Question 8. Do you agree with the other changes to the guidelines to reflect updates from Regulation (EU) 2024/1623?
EBF agrees with the other changes proposed, aimed at ensuring alignment of the updated Guidelines with the Level 1 text. The EBF also adds complimentary information that could provide a useful refinement within the proposed guidelines.
Materiality thresholds for days-past-due amount for non-retail exposures:
Another possible improvement concerns the increase of the absolute materiality threshold for days-past-due amounts. In the monitoring of defaulted exposures, banks favour a right balance between the need to focus on increased risk and the level of amount to which banks are exposed (in particular to possible loss levels). Reviewing the absolute threshold would help banks in the risk monitoring of non-retail exposures to concentrate the effort more on significant cases.[1]
Proportionate approach in NPV test computation:
We understand that CRR and EBA Guidelines provide a proportionate approach of the NPV test computation so we would like the EBA to provide better clarity in the Guidelines to ensure common reading between banks and supervisors.
First, we would propose to reword the paragraph 52 to align with CRR3 and the fact that the NPV test is only required in the objective of identifying defaults triggered by the diminished financial obligation which is induced by the forbearance measure (thus the NPV test needs not to be performed when the exposure defaults for other reasons).
Paragraph 52 of EBA Guidelines details “For the purposes of unlikeliness to pay as referred to in point (d) of Article 178(3) of Regulation (EU) No 575/2013, for each distressed restructuring, institutions should calculate the diminished financial obligation and compare it with the threshold referred to in paragraph 51. Where the diminished financial obligation is higher than this threshold, the exposures should be considered defaulted.
We recommend replacing the phrase “for each distressed restructuring” in paragraph 52 with:
“for any exposure that is subject to a forbearance measure and may be in default due to that measure, especially if it leads to a reduced financial obligation through significant forgiveness or postponement of principal, interest, or applicable fees.” In addition, we propose to add at the end of the paragraph “For the avoidance of doubt, the NPV test should only be performed for exposures subject to forbearance measures and have not been recognised as defaulted yet”.
Indeed, such nuance is crucial as we understand that CRR targets the identification of default by performing NPV test only when the trigger is the forbearance measure likely to result in a diminished financial obligation due to the material forgiveness, or postponement, of principal, interest or, where relevant, fees. This is concurred by the following references:
- In the level 1 text, article 178.3(d) of CRR was modified in CRR3 and now indicates: “For the purpose of point (a) of paragraph 1, elements to be taken as indications of unlikeliness to pay shall include the following […] (d) the institution consents to a forbearance measure as referred to in Article 47b of the credit obligation where that measure is likely to result in a diminished financial obligation due to the material forgiveness, or postponement, of principal, interest or, where relevant, fees;”
- Paragraph 50 of the EBA Guidelines specifies “given that, as referred to in point (d) of Article 178(3) of Regulation (EU) No 575/2013, the obligor should be considered defaulted where the distressed restructuring is likely to result in a diminished financial obligation, where considering forborne exposures, the obligor should be classified as defaulted only where the relevant forbearance measures are likely to result in a diminished financial obligation.”
- EBA feedback on the consultation of the first version of the Guidelines on definition of default mentions page 99 that “As the calculation of NPV should be applied for the purpose of the identification of default, it only applies to those exposures that are subject to distressed restructuring and have not been recognised as defaulted yet […]”
As paragraph 52 of EBA Guidelines only mentions “for each distressed restructuring”, there could be diverse supervisory understanding which deems for instance that the NPV test should be performed systematically for every exposure subject to forbearance measure, even if such exposure is subject to other default triggers (such as UTP or DPD) and is put into default in any case. From a pragmatic point of view, we would like to highlight that when the NPV test is performed for a forborne exposure only when the exposure has not defaulted yet for other triggers, this leads to the same outcomes that performing the NPV test systematically for every forborne exposure (in terms of status of default for obligors, same duration of probation period - 12 months - as the forbearance is identified before possible need to perform NPV test). This is why a more proportionate approach regarding performing the NPV test should be clearly mentioned in the EBA Guidelines.
Reset of probation period for forborne exposures:
We also deem that this point deserves to be clearly mentioned in the EBA Guidelines to ensure common reading between banks and supervisors.
EBA provides clarification in Q&A 2022_6527 on the reset of probation period regarding forborne exposures. In particular, the following part of the EBA response to the Q&A should be reflected in the EBA Guidelines regarding forborne exposures in order to provide common understanding (across supervisors):
“Since Article 47a(3)(c) of the CRR requires an exposure that has been under distressed restructuring to be considered as non-performing in the case it becomes more than 30 days past due, there is a rebuttable presumption that the probation period referred to in paragraph 72 of the guidelines on the definition of default should be reset as soon as the exposure becomes more than 30 days past due, unless this delayed payment is not related to financial difficulties of the obligor.”
Such clarification provides further alignment between NPE and default and implies that the probation period for defaulted exposures is not reset to zero when the obligor is not more than 30 days past due.
[1] EBF acknowledges an RTS modification is beyond the remit of the amended GL, however the intention is to bring awareness to this aspect for future considerations.