Does an institution which has been granted permission to use the IRB Approach, including to use own estimates of LGD and conversion factors have the option to use the credit risk mitigation techniques of Chapter 4 (general CRM rules) of Regulation (EU) No 575/2013 (CRR), or must it make adjustments using its own estimates?
Do the requirements for recognition of CRM under Chapter 4 apply to AIRB firms, or are these superseded by the Chapter 3, Section 6 requirements for IRB firms, including Article 183 CRR regarding recognition of unfunded credit protection for AIRB firms?
For the purposes of Art 161(3) CRR, how does one determine the relevant risk weight of "a comparable, direct exposure to the guarantor"? Art 161(4) CRR gives guidance, but this is specifically with regard to the application of Art 153(3) CRR, i.e.: the "double default" approach. Is Art 161(4) CRR also relevant for Art 161(3) CRR?
Is the "double default" approach detailed in Art 153(3) CRR and in Chapter 4 (Articles 202 and 217 CRR) also available for AIRB firms?
Article 161(1)(c) CRR states that institutions may recognise funded and unfunded credit protection in the LGD in accordance with Chapter 4 (Art 192-241 CRR), while Article 161(3) CRR stipulates that AIRB firms can adjust PD or LGD subject to the requirements of Section 6 (Art 169-191). The use of the term "may" in both Art 161(1)(c) and Art 161(3) suggests both are options for AIRB firms.
Also, as Article 161(3) CRR specifically does NOT reference Chapter 4, it appears these requirements are limited to application of the techniques outlined in Chapter 4 only, and not applicable to AIRB firms' adjustments of PD or LGD under Article 161(3) CRR.
According to Article 108(2) CRR, for an exposure for which the risk weighted exposure amounts are to be determined under the IRB Approach by using own estimates of LGD and conversion factors under Article 151 CRR, an institution may recognise credit risk mitigation in accordance with Chapter 3. For those exposures, Chapter 4 only applies where this is required under Chapter 3. Therefore, to recognise unfunded credit protection in the PD or LGD of an exposure, for which own estimates of LGD are used, an institution has to comply with the requirements under Article 183 CRR (which leads to applying Chapter 4 for specific cases referred to in paragraph 4 of this Article). Another method to include the effect of unfunded credit protection under Chapter 3 is described in Article 153(3) CRR which also refers to selected articles of Chapter 4.
Under Article 161 CRR and the conditions described therein, unfunded credit protection for an exposure, for which own estimates of LGD have to be used, can be recognised by paragraph 3 or paragraph 4, if applicable.
Article 161(3) CRR requires institutions using own LGD estimates for exposures to corporates, institutions, central governments and central banks that the adjusted risk weight of the guaranteed exposure determined by using an adjusted PD or LGD shall not be lower than that “of a comparable, direct exposure to the guarantor”.
For this purpose, if the institution applies the IRB approach to a comparable direct exposure to the guarantor and has the permission to use its own estimates of LGD, the institution may determine the risk weight of a comparable, direct exposure to the guarantor by using the PD and the LGD that it would assign to such exposure. Q&A 415 specifies that this comparable and direct exposure can be calculated using the same risk-weight function. On the other hand, if a comparable, direct exposure to the guarantor would be treated under the Standardised Approach, the risk weight of such exposures for the purpose of Article 161(3) CRR should be determined in accordance with the Standardised Approach.
Article 153(3) CRR is applicable irrespective of whether an institution has to use supervisory LGD values or own estimates of LGD for the respective exposures. Article 161(4) clarifies how to determine the LGD parameter for this purpose.
Please see also Q&A 2013_27.
Further clarifications were provided in the EBA Guidelines on Credit Risk Mitigation for institutions applying the IRB approach with own estimates of LGDs.
Update 26.03.2021: This Q&A has been updated in the light of the changes introduced to Regulation (EU) No 575/2013 (CRR).