Question ID
2014_803
Legal act
Regulation (EU) No 575/2013 (CRR)
Topic
Credit risk
Article
Article 215 - Additional requirements for guarantees
Paragraph
1
Subparagraph
(a)
COM Delegated or Implementing Acts/RTS/ITS/GLs/Recommendations
Not applicable
Article/Paragraph
na
Name of institution / submitter
Magyar Nemzeti Bank
Country of incorporation / residence
Hungary
Type of submitter
Competent authority
Subject matter
Effect on the capital requirement of a guarantee where the right to call is linked to default versus another where it is linked to realised loss
Question

Let’s take a portfolio level guarantee that is callable once losses from the exposures covered have been realised (and NOT when exposures DEFAULT); realised losses decrease the notional of the guarantee. As it can take years till losses get realised after the default event, while losses are still unrealised (but defaults have happened) the full notional is used to cover the whole portfolio. Our question is whether such a guarantee is eligible to be taken into account as unfunded credit protection and thus decrease the capital requirement of the sub-portfolio it cover?

Background on the question

Let’s assume a simplified situation where we have a portfolio of 100 units, capital requirement (according to IRB) of 10, a guarantee of 10 that, say, decreases the capital requirement to 0. The guarantee covers realised losses. If realising losses takes 3 years, then 5 units of expected losses in year 1 will mean that in year 4 5 units of the guarantee is expected to be used. In year 2 the guarantee can only cover 5 units of additional loss (expectedly), still, its notional will be 10. In year 2 by how much should the guarantee decrease the capital requirement, 5 or 10 units? Regulators have already raised concerns relating to securitisations (including synthetic securitisations a type of which uses guarantees): BIS "Recognising the cost of credit protection purchased", March, 2013 and Basel Committee newsletter No. 16. "High cost credit protection".

Submission date
Final publishing date
Final answer

Under Article 215 of Regulation (EU) No. 575/2013 (CRR), a guarantee may only qualify as eligible unfunded credit protection where all of the conditions set out in that article and all of the conditions in Article 213 are met.  If, by the terms of the guarantee, the lending institution does not have the right to pursue the guarantor for any monies due but unpaid until such time as losses from the guaranteed exposures have been realised (the timing of which is indeterminate), neither the conditions of Article 215(1)(a) nor Article 213(1)(c) of the CRR, particularly point (iii), would be met.

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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