Question ID
2013_415
Legal act
Regulation (EU) No 575/2013 (CRR)
Topic
Credit risk
Article
161
Paragraph
3
Subparagraph
-
COM Delegated or Implementing Acts/RTS/ITS/GLs/Recommendations
Not applicable
Article/Paragraph
Not applicable
Type of submitter
Credit institution
Subject matter
Unfunded credit protection; adjusting PD or LGD; coefficient of correlation large financial sector entities or unregulated entities
Question

1. Under Article 161(3) of CRR, can unfunded credit protection be recognised by adjusting PD or LGD, but not both? 2. If the institution has a subordinated exposure to an obligor, and a guarantee is recognised by adjusting the PD under Article 161(3), is it allowed to also adjust the LGD for the subordinated exposure and use a LGD associated with a senior claim on the obligor or guarantor, if the guarantee would represent a senior claim on the guarantor (compare with Article 236(1)). 3. (a) If an institution is recognising unfunded credit protection by adjusting or substituting the PD under Article 161(3) for an exposure for which article 153(2) is not applicable, should it also adjust the coefficient of correlation from the obligor to the guarantor, including applying the multiplier of 1.25, in case unfunded credit protection has been received from a large financial sector entity as defined in Article 142(1)(4), or unregulated financial entity as defined in Article 142(1)(5). (b) If an institution is recognising unfunded credit protection by adjusting or substituting the PD under Article 161(3) for an exposure for which article 153(2) is applicable, should it also adjust the coefficient of correlation (multiplied by 1.25), in case unfunded credit protection has not been received from a large financial sector entity as defined in Article 142(1)(4), or unregulated financial entity as defined in Article 142(1)(5), but, for example, from a large corporate or sovereign. 4. (a) If an institution is recognising unfunded credit protection by adjusting the LGD under Article 161(3) for an exposure for which Article 153(2) is not applicable, should it also adjust the coefficient of correlation, including applying the multiplier of 1.25, in case unfunded credit protection has been received from a large financial sector entity as defined in Article 142(1)(4), or unregulated financial entity as defined in Article 142(1)(5). (b) If an institution is recognising unfunded credit protection by adjusting the LGD under Article 161(3) for an exposure for which Article 153(2) is applicable, should it also adjust the coefficient of correlation (multiplied by 1.25), in case unfunded credit protection has not been received from a large financial sector entity as defined in Article 142(1)(4), or unregulated financial entity as defined in Article 142(1)(5) , but, for example, from a large corporate or sovereign.

Background on the question

Ad 1: The wording of CRR (575/2013) Article 161(3) has changed as compared to CRD (48/2006/EC) Annex VII, Part 2, paragraph 10. In particular, CRD (48/2006/EC) Annex VII, Part 2, paragraph 10 stipulates “…unfunded credit protection may be recognised by adjusting PD and/or LGD…”, whereas CRR (575/2013) Article 161(3) stipulates “…unfunded credit protection may be recognized by adjusting PD or LGD…”. Ad 2: Please compare to CRR (575/2013) Article 236(1). Ad 3/4: The BIS Basel II Framework, published June 2006, (BCBS128) suggests adjustment of the RW function in case of unfunded credit protection in paragraph 303: “Eligible guarantees from eligible guarantors will be recognised as follows: For the covered portion of the exposure, a risk weight is derived by taking: the risk-weight function appropriate to the type of guarantor […]”. However, CRR (575/2013) does not explicitly require adjustment of the correlation coefficient.

Submission date
Final publishing date
Final answer
Ad 1) Article 161(3) of Regulation (EU) No 575/2013 should not be read as preventing banks from adjusting where appropriate both PD and LGD. As a matter of fact, it would be counterintuitive to allow less freedom in the recognition of unfunded credits to more advanced banks applying the IRB than it is allowed to less sophisticated banks according to Article 236(1). Furthermore, although Article 161(3) does not prevent the adjustment of both PD and LGD, such adjustments cannot lead to recognising the effect of the same unfunded credit protection more than once. Ad 3) and 4): Neither Article 161(3) nor 236(1) require the use of a different risk weight function or asset value correlation. DISCLAIMER:This question goes beyond matters of consistent and effective application of the regulatory framework. A Directorate General of the Commission (Directorate General for Internal Market and Services) has prepared the answer, albeit that only the Court of Justice of the European Union can provide definitive interpretations of EU legislation. This is an unofficial opinion of that Directorate General, which the European Banking Authority publishes on its behalf. The answers are not binding on the European Commission as an institution. You should be aware that the European Commission could adopt a position different from the one expressed in such Q&As, for instance in infringement proceedings or after a detailed examination of a specific case or on the basis of any new legal or factual elements that may have been brought to its attention. 
Status
Final Q&A
Answer prepared by
Answer prepared by the European Commission because it is a matter of interpretation of Union law.
Note to Q&A

Update 26.03.2021: This Q&A has not yet been reviewed by the European Commission in the light of the changes introduced to Regulation (EU) No 575/2013 (CRR).

Disclaimer

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