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Austrian Federal Economic Chamber

We would note that the managerial options in a downturn are potentially more effective for CF than for LGD: During first signs of stress, credit line management might be quickly adjusted to stabilize or even reduce observed CFs. Observed LGDs, however, cannot be influenced so easily. Expected cash flows will suffer from the higher number of defaults and the general stress in the environment, which makes it much more likely to actually observe increased downturn LGDs.
Definition of model components is not very clear and we think it can be interpreted in various ways. It is also very complex and complicates the calculation greatly, since it means that not only one but also multiple downturn add-on values shall be calculated.
Many of the proposed macro variables, especially the market indices, can be difficult to obtain back to history.
20 years of suggested time horizon is a very high number compared to the data availability for the most of us. If this is not fulfilled, addition MoC is to be applied on downturn add-on, which is another complication – how should this be determined?
We find the model component approach preferred by EBA too complex, combining strict methodology prescription and subjective input from the panel of experts. Such a methodological approach requires verification of significant underlying assumptions and might increase model risk and uncertainty. Such an increased complexity could even contradict the current EBA approach, which aims to reduce model risk through a variety of consultations and methodological harmonization.
Consequently, we believe that the Reference value approach is more adequate as it defines a common frame for estimation and at the same time gives freedom in estimating the final LGD. This approach allows using model component downturn estimation if appropriate for the bank.
Generally, we prefer approaches that define common estimation framework, but that also allow the banks to select a methodology tailored to their environment.
Dr. Franz Rudorfer