- Question ID
-
2015_2063
- Legal act
- Regulation (EU) No 575/2013 (CRR)
- Topic
- Credit risk
- Article
-
166
- Paragraph
-
8, 9, 10
- COM Delegated or Implementing Acts/RTS/ITS/GLs/Recommendations
- Not applicable
- Article/Paragraph
-
not applicable
- Type of submitter
-
Individual
- Subject matter
-
Determination of the exposure at defaul in case of unfunded credit protection
- Question
-
Under the advanced approach, the IRB Approach, as permitted by the Title II - Chapter 3, does not specify the order of application of the Credit Conversion Factor (CCF) and of the credit protection when an off-balance sheet exposure is covered by an unfunded credit protection (e.g. a CDS, Credit Default Swap). Does CRR prevent from applying the credit protection on the Exposure At Default (i.e.: after application of the CCF for an off-balance sheet exposure)?
- Background on the question
-
If CRR is presciptive on the way unfunded credit protection is taken in account in the calculation of the exposure at defaut for the purpose of calculating the effect of credit risk miigants, there are no prescriptive requirement under the IRB Advanced approach.
- Submission date
- Final publishing date
-
- Final answer
-
Unfunded credit protection is not recognised by amending the exposure value but
(a) either by adjusting PD or LGD estimates, according to Articles 108(2), 164(2) and 183(1) to (3) CRR, in case an institution uses own estimates of LGDs and conversion factors;
(b) or by replacing the PD and/or the LGD (as applicable) for the portion of the exposure value covered by the adjusted value of the unfunded credit protection, according to Articles 108(2) and 236(1) CRR.
Therefore, applying a conversion factor or a certain percentage in the calculation of the exposure value does not prevent from recognising unfunded credit protection.
When an institution does not use own estimates of LDGs and conversion factors, the CRR prescribes an order for the determination of the covered portion of the exposure value. Per Article 236(3) CRR the exposure value considered for this purpose is to be calculated by applying a conversion factor or percentage of 100% instead of the conversion factors or percentages applicable in the calculation of the exposure value. The covered portion of the exposure value is therefore to be determined in relation to the total value of off-balance sheet items listed in Article 166(8) to (10) CRR.
In contrast, when an institution uses own estimates of LGDs and conversion factors, recognition of unfunded credit protection does not require the separate identification of a covered portion of the exposure value, because risk mitigation by unfunded credit protection may be recognised by directly adjusting PD or LGD estimates in accordance to Article 164(2) CRR. Instead, as prescribed by Article 183(2) CRR, an institution shall have clearly specified criteria to reflect the impact of guarantees. This would not prevent the institution from considering exclusively the exposure value resulting from the application of the conversion factors or percentages according to Article 166(8) to (10) CRR. On the contrary, it is explicitly required when recognising unfunded credit protection by adjusting the LGD, that is defined in Article 4(1)(55) CRR as the ratio of the loss on an exposure due to the default of a counterparty to the amount outstanding at default.
- Status
-
Final Q&A
- Answer prepared by
-
Answer prepared by the EBA.
- Note to Q&A
-
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.