Question ID:
2016_2702
Legal Act:
Regulation (EU) No 575/2013 (CRR)
Topic:
Credit risk
Article:
159
COM Delegated or Implementing Acts/RTS/ITS/GLs/Recommendations:
Not applicable
Article/Paragraph:
N.A.
Disclose name of institution / entity:
Yes
Name of institution / submitter:
Bulgarian National Bank
Country of incorporation / residence:
Bulgaria
Type of submitter:
Competent authority
Subject Matter:
Application of Article 159 on the level of total own funds
Question:

Can the excess of provisions for non-defaulted exposures be used to cover the shortfall of provisions on defaulted exposures?

On the reporting side, which of the two options is the correct way for the own funds reporting (C 04.00) in the following case?

Option 1 – netting in C.01.00 row 380 “(-) IRB shortfall of credit risk adjustments to expected losses“ – (1000) row 910 „IRB Excess of provisions over expected losses eligible“ – 600 Effect to the total capital – minus 400

Option 2 – no netting at all (no recognition of any excess because it is on defaulted exposures) row 380 “(-) IRB shortfall of credit risk adjustments to expected losses“ – (1000) row 910 „IRB Excess of provisions over expected losses eligible“ – 0 Effect to total capital – minus 1000 

Background on the question:

According to Article 159 (CRR) specific credit risk adjustments on exposures in default shall not be used to cover expected loss amounts on other exposures. According to Q&A 573the amount of shortfall or excess of provisions should be calculated on an aggregate level for IRB exposures, separately for defaulted and non-defaulted exposures. The excess of provisions for defaulted exposures cannot be used to cover the shortfall of provisions for non-defaulted exposures. However, there is no provision in the CRR which prevents the excess of provisions for non-defaulted exposures being used to cover the shortfall of provisions on defaulted exposures”.

Q&A 573 seems to be written down only for the case where IRB shortfall of credit risk adjustments to expected losses for non-defaulted exposures and IRB excess of specific credit risk adjustments to expected losses for defaulted exposures do not materialise simultaneously. Therefore option 1 seems to run contrary to the logic of Art. 159 as it allows for coverage of the shortfall of provisions for non-defaulted exposures by the excess of provisions for defaulted exposures at the level of total own funds. In our opinion the answer given in Q&A 573 covers only effect on CET1, T1, T2, but not the overall effect on total own funds.

Assumptions (reporting in C.04.00): row 100 - IRB shortfall of credit risk adjustments to expected losses for non-defaulted exposures – (1000) row 145 - IRB excess of specific credit risk adjustments to expected losses for defaulted exposures – 4000 row 160 Risk weighted exposure amounts for calculating the cap to the excess of provision eligible as T2 – 100000 (eligible amount for inclusion in T2 - 600) Reporting in C.01.00

Date of submission:
11/04/2016
Published as Final Q&A:
10/03/2017
Final Answer:

Article 159 of Regulation (EU) No 575/2013 (CRR), regarding the treatment of expected loss amounts for institutions under IRB approach, specifies that Specific Credit Risk Adjustments (SCRAs) on exposures in default shall not be used to cover expected loss amounts on other (i.e. non-defaulted) exposures. This means that the excess of provisions for defaulted exposures cannot be used to cover the shortfall of provisions on non-defaulted exposures (if any). However, there is no provision in the CRR which prevents the excess of provisions for non-defaulted exposures being used to cover the shortfall of provisions on defaulted exposures.

In practice, as already said in Q&A 573, the amount of shortfall or excess of provisions should be calculated on an aggregate level for IRB exposures separately for defaulted and non-defaulted (expected loss amounts for securitised exposures and general and specific credit risk adjustments related to these exposures shall not be included in this calculation). If there is a net shortfall of provisions on defaulted exposures shall then be netted with the net excess of provision on non-defaulted exposures. Should this netting result in a net shortfall of provisions, it will be reported (deducted from CET1) under row 380 of template C 01.00 of Annex I of Regulation (EU) N°680/2014 (ITS on supervisory reporting). Otherwise, where such netting results in an excess of provisions, it should then be added to Tier 2 items under row 910 of the above C 01.00 template up to 0,6 % of IRB risk weighted exposure amounts, as stated in article 62(d) of the CRR.

 

Example 1:

defaulted exposures: net shortfall of provisions of 1000

non-defaulted exposures: net excess of provisions of 600

Netting between defaulted and non-defaulted exposures is allowed – an overall net shortfall of provisions of 400 to be deducted from CET1

 

Example 2:

defaulted exposures: net shortfall of provisions of 1000

non-defaulted exposures: net excess of provisions of 1200

Netting between defaulted and non-defaulted exposures is allowed – an overall net excess of provisions of 200 to be added to Tier 2 up to the threshold specified in Article 62(d) of the CRR

Where the separate calculation for a portfolio of exposures that are in defaults and an overall non-defaulted portfolio result in an excess of provisions on defaulted exposures and shortfall on non-defaulted exposures then netting between those portfolios is not allowed. The treatment of such situation is illustrated on the following examples:

Example 3:

defaulted exposures: net excess of provisions of 1000

non-defaulted exposures: net shortfall of provisions of 600

Netting between defaulted and non-defaulted exposures is not allowed – a shortfall of provisions of 600 to be deducted from CET1 and an  excess of provisions of 1000 to be added to Tier 2 up to the threshold specified in Article 62(d) of the CRR.

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.

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