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?
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.
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.