Question ID:
2017_3270
Legal Act:
Regulation (EU) No 575/2013 (CRR)
Topic:
Credit risk
Article:
34, 105, 111
Paragraph:
1
COM Delegated or Implementing Acts/RTS/ITS/GLs/Recommendations:
Regulation (EU) No 183/2014 - RTS for the calculation of specific and general credit risk adjustments
Article/Paragraph:
Article 1, paragraph 1
Disclose name of institution / entity:
No
Type of submitter:
Competent authority
Subject Matter:
Appropriate Risk Weight for purchased defaulted assets
Question:

Where an entity subject to the CRR purchased Non-Performing Loans booked at the purchase price (net book value, “NBV”), which is significantly below the loans’ gross book value (“GBV”), can the difference between GBV and NBV be treated as specific credit risk adjustment when deciding whether a risk weight of 100% (rather than 150%) applies according to Article 127 CRR?

Background on the question:
The exposure value (EV) of a loan, according to Article 111 CRR “... shall be its accounting value remaining after specific credit risk adjustments”.
 
Furthermore, Article 127(1) CRR, in accordance with Article 178 CRR, assigns the following risk weights to the unsecured part of a defaulted exposure: “(a) 150% where specific credit risk adjustments are less than 20% [of GBV] of the unsecured part of the exposure value if these specific credit risk adjustments were not applied; (b) 100% where specific credit risk adjustments are no less than 20% [of GBV] of the unsecured part of the exposure value if these specific credit risk adjustments were not applied”.
 
In general, in the case of defaulted exposures (as per Article 178 of CRR) a bank records both the original GBV and the specific credit risk adjustments computed in accordance with the relevant accounting rules (IAS 39 in the case of loans and receivables); it is therefore straightforward to check whether specific credit risk adjustments exceed 20% of the GBV.
 
However, in the case of an asset management company (“bad bank”) buying defaulted exposures from a bank, the exposures are directly booked at the purchase price (NBV). Nevertheless, in our opinion, the data on GBV provided by the seller can be used to show the difference between GBV and NBV, which performs the same economic role as a specific credit risk adjustment. Namely, the amount IC = 1-NBV/GBV provides a measure of “Implicit Coverage” (“IC”) for each exposure, and can be compared to the 20% threshold to see whether a risk weight of 100% (instead of 150%) applies. To the best of our knowledge, however, the use of the “IC” measure is not explicitly foreseen by any provision in the CRR.
 
Rationale for the question is that the purchaser of an NPL portfolio is subject to CRR and computes the capital requirement against credit risk under the Standardised Approach (based on Articles 127 and 178 of the CRR). The purchased NPLs are booked at the purchase price (net book value, “NBV”), which is significantly below the loans’ gross value (“GBV”).
 
The AMC, even booking at NBV the defaulted exposures, has the GBV data on its records.
Date of submission:
12/04/2017
Published as Final Q&A:
21/09/2018
Final Answer:

According to Article 111(1) of Regulation (EU) No 575/2013 (CRR), under the standardised approach (SA) the exposure value (EV) of a loan shall be its accounting value remaining after specific credit risk adjustments in accordance with Article 110, additional value adjustments in accordance with Articles 34 and 105 110, amounts deducted in accordance with point (m) Article 36(1) and other own funds reductions related to the asset item have been applied.

 

The reference to the accounting value is in line with Article 24(1) CRR, which clarifies that “the valuation of assets and off-balance sheet items shall be effected in accordance with the applicable accounting framework”, as defined in Article 4(1)(77) CRR. In this sense, the CRR provisions do not prescribe what should be recorded in the balance sheet, but they rather take what is recorded on the balance sheet of an institution in accordance with applicable accounting rules as a starting point for prudential purposes.

 

Article 4(1)(95) CRR defines “credit risk adjustment” as the amount of specific and general loan loss provision for credit risks that has been recognised in the financial statements of the institution in accordance with the applicable accounting framework. 

 

Additionally, for the purposes of the exposure value referred to in Article 111 CRR, Article 1(1) of Regulation (EU) No 183/2014 (RTS on the specification of the calculation of specific and general credit risk adjustments) specifies that the amounts required to be included in the calculation of general and specific credit risk adjustments by an institution shall be equal to all amounts by which an institution’s Common Equity Tier 1 capital has been reduced in order to reflect losses exclusively related to credit risk according to the applicable accounting framework and recognised as such in the profit or loss account, irrespective of whether they result from impairments, value adjustments or provisions for off-balance sheet items.

 

As a consequence, with the exception of the provision set out in Article 1(6) of Regulation (EU) No 183/2014 as amended by Commission Delegated Regulation (EU) 2022/954 of 12 May 2022, unless amounts satisfy the above conditions and are calculated in accordance with the provisions specified in Regulation (EU) No 183/2014, they cannot be considered credit risk adjustments for the purposes of Article 111 CRR and Article 127 CRR.

 

Article 1(6) of Regulation (EU) No 183/2014 as amended by Commission Delegated Regulation (EU) 2022/954 of 12 May 2022 specifies that institutions, when calculating the specific credit risk adjustments for the purposes of assigning the risk weights referred to in Article 127(1), points (a) and (b), of Regulation (EU) No 575/2013 to the unsecured part of a defaulted exposure, shall include in the amount of specific credit risk adjustments the positive difference between the amount owed by the obligor on that exposure and the sum of the following: (a) the additional own funds reduction if that exposure was written-off fully and (b) any already existing own funds reductions related to that exposure. However, the inclusion of this amount in specific credit risk adjustments is limited to Article 127 (1) points (a) and (b) CRR and has no impact on the exposure value of the defaulted exposure in accordance with Article 111 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 updated in the light of the changes introduced to Regulation (EU) No 575/2013 (CRR).

Update 11.11.2022: the Q&A has been updated to take into account the amendments introduced by Commission Delegated Regulation (EU) 2022/954 of 12 May 2022. The changes affect the last two paragraphs of the EBA answer.

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