Does expression “part of the loan” refer to gross or net exposure? Which approach is correct?
According to Article 125 (2) (d) of Regulation (EU) No 575/2013 (CRR), the part of the loan to which the 35% risk weight is assigned does not exceed 80% of the market value of the property. e.g. Exposure with gross value = 1 200 000 EUR, credit risk adjustments = 500 000 EUR, net value = 1 200 000 – 500 000 = 700 000 EUR, is secured by real estate with market value = 1 000 000 EUR (80% of market value = 800 000 EUR). Collateral meets all requirements to enable assignment of preferential risk weight. If Art. 125 2. (d) refers to net value, then whole exposure (700 000 EUR) is covered by collateral (800 000 EUR) and might be treated as fully and completely secured, using preferential risk weight.
For the purpose of Article 125(2)(d) of Regulation (EU) No. 575/2013 (CRR), the part of the loan to which the 35% risk weight is assigned is to be determined after specific credit risk adjustments (i.e. it should be assigned to the net exposure).
According to Article 113(2) of CRR, risk weights are applied by multiplying the exposure value by the risk weight. According to Article 111(1) of CRR, exposure values of asset items, including asset items resulting from a loan, are determined after specific credit risk adjustments.
Note, however, that one potential indication of an obligor being unlikely to pay under the definition of default are specific credit risk adjustments resulting from a significant perceived decline in credit quality subsequent to the institution taking on the exposure (Article 178(3)(b) of CRR). If a default has occurred in accordance with Article 178, the 35% risk weight is no longer applicable because in this case Article 127 requires assigning a risk weight of 100% to the exposure value remaining after specific credit risk adjustments of exposures fully and completely secured by mortgages on residential property in accordance with Article 125.
Update 26.03.2021: This Q&A has been reviewed in the light of the changes introduced to Regulation (EU) No 575/2013 (CRR) and continues to be relevant.