Under the standardised approach, when calculating the unsecured part of the exposure for the purpose of computing provisions threshold (20%) under Article 127(1) of the CRR, shall the exposure exclude eligible financial collateral and credit protection that comply with the requirements stated in Part Three, Title II, Chapter 4 of the CRR, ‘Credit Risk Mitigations’, as well as residential real estate and commercial real estate as described in Article 127(3) & (4) of Regulation (EU) No 575/2013?
By definition, the amount covered by eligible real estate property is secured. Therefore if we have a defaulted exposure of 100 that has the following portions: Α: 30 secured by residential real estate (that would otherwise take a 35% risk weighting if not in default), which comply with the requirements for CRM B: 20 secured by residential real estate, which does not comply with the requirements for CRM C: 10 secured by cash collateral D: 40 unsecured (or secured by other collateral or guarantees which do not comply with the requirements of CRM). Total specific credit risk adjustments: 9 (allocated to portion D only) As the specific credit risk adjustments are no less than 20% of the unsecured part of the exposure value if these were not applied (9/40 = 22.5%), we would expect that portion A (30) would receive a 100% risk weighting in accordance with Article 127(3) CRR, whereas portion D (taking into account specific credit risk adjustments(40 - 9 = 31) would receive a risk weight of 100% in accordance with Article 127(1)(b) CRR.
For the purposes of Article 127(1) of Regulation (EU) No 575/2013 (CRR), in the case of exposures in default which are secured by immovable properties, the unsecured part of such exposure is the difference between the gross exposure value and the part(s) of the exposure fully and completely secured by mortgages on immovable property determined in accordance with Articles 124, 125(2) and 126(2) CRR, as applicable.
In addition, the unsecured part of an exposure in default (represented by Portion D (40) in the example above) does not include exposures secured by other eligible collaterals or guarantees that fulfil the criteria of Part Three, Title II, Chapter 4 of the CRR.
Hence, per the example, supposing that 30 is the fully and completely secured part of the exposure determined according to Articles 124 and 125(2) CRR (which is less than 80 % of the market value or mortgage lending value), as applicable, this would result in an unsecured exposure equal to 100 – 30– 10(eligible cash collateral) = 60 (not taking into account specific credit risk adjustments).
Accordingly, the prudential treatment of such exposures in default would be:
- The unsecured part (i.e. exposure value 60-9 = 51) should be subject to a risk weight equal to 150%, as the ratio between the provisions and the unsecured exposure (9/60) is lower than 20%;
- The part fully and completely secured by mortgages on immovable property (30) should be subject to a risk weight equal to 100% according to Article 127(3) (in case of exposures secured by residential immovable property) or 127(4) (in case of exposures secured by commercial immovable property);
- The part secured by cash collateral should be deducted from the exposure value, or assigned a risk weight of 0%, in accordance with Article 111(3) and Part Three, Title II, Chapter 4, depending on the method which the institution uses (Financial Collateral Simple Method or Financial Collateral Comprehensive Method).
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.