In the case of retail exposures, can the default definition be implemented in a way that the default of an exposure secured by mortgage extends to unsecured facilities, but not the other way round?
Alternatively, should a bank implement the default definition within the retail non SME portfolio consistently at the level of facility, i.e. at the level of product type without extending the default to other facilities?
According to Article 178 CRR the bank can apply in the retail portfolio the default definition at the level of client or at the level of facility (facility not being exactly defined).
One institution implemented the default definition in retail as follows:
1. In the case of Retail Small Business (SME) segment the implementation is clear: clients are different from other retail clients and the default flag is attached only within this group, at the level of a client. It means that if one exposure of the client defaults, the whole client is treated as defaulted and all exposures of the bank to such a client have a default status (this approach is considered as default at the client level within this segment/product group).
2. The rest of retail portfolio – Retail non SME is divided into two main categories:
a. Retail unsecured (this segment is under STD by now) – all unsecured loans If a client has e.g. 3 credit cards and 2 consumer loans and default occurred at any of these exposures/loans, such a client is considered as defaulted and in the RWA calculation all 5 exposures are treated as defaulted (i.e. the information of the default status is transferred within these groups of product). The above mentioned default status is not transferred to the exposures in the segment “Retail mortgage” in the case of particular client. However, the opposite transfer is possible. If the default occurred in the exposure in the “Retail mortgage” segment, the client is treated as defaulted also in the segment “Retail unsecured”. This approach to the default definition is called by the bank “client level approach”.
b. Retail – mortgages (IRB approach) –all loans secured by a mortgage (residential/commercial) If a client has e.g. 3 mortgage loans and default occurred at any of these exposures, only the particular exposure is considered as defaulted (PD=1 in RWA calculation), the other two exposures are treated as not defaulted (PD different from 1). In this segment (mortgage loans) the information about the default is not transferred to other mortgage loans and neither to the “Retail unsecured” segment. Although there is no definition of individual credit facility in the CRR, this approach to the default definition is called by the bank “facility level approach”. As a consequence the same parameter can lead to status "default" and "non-default".
Article 178(1) of Regulation (EU) No 575/2013 (CRR) permits applying the definition of default at the level of an individual credit facility in the case of retail exposures. Except from being a retail exposure, the CRR specifies no further conditions. In particular, there are no additional restrictions to the information which an institution may take into account for identifying whether it considers that an obligor is unlikely to pay the credit obligations related to the individual credit facility as specified by Article 178(1)(a) CRR, i.e. the default may be considered to extend to other credit facilities through adequate specification of additional indications of unlikeliness to pay for these specific types of retail facilities. However, where the definition of default is applied at the obligor level, default is recognised on all exposures of an obligor at the same time.
As a consequence, for applying the definition of default at the level of a specific individual credit facility for the Retail portfolio, institutions may in particular consider default events on other individual credit facilities for the same obligor as relevant information if this provides for a meaningful assessment of obligor and transaction characteristics. In the case of the IRB Approach institutions should also specify the indications of unlikeliness to pay in such a way that:
(1) they ensure a meaningful differentiation of risk and accurate and consistent quantitative estimates of risk as required by Article 144(1)(a) CRR; and
(2) the internal rating of the specific credit facility, in particular the classification of exposures as defaulted, plays an essential role in the processes required by Article 144(1)(b) CRR.
Further clarifications on this topic are to be found in the EBA Guidelines on the application of the definition of default, paragraphs 86 to 105.