Regarding the applicable amount of the insufficient coverage to be deducted from own funds as per Article 36 (1) (m) CRR, to be determined at exposure level according to Article 47c(1) (b) of Regulation (EU) 2019/630, should the credit institutions applying the IRB approach consider the Pillar 1 capital absorptions already computed for credit risk for the calculation, on the same exposure, of the applicable amount to be deducted from CET 1 as per above, precisely to avoid any double-counting?
The Regulation (EU) 2019/630 (hereafter the "Backstop Regulation") has introduced minimum loss coverage levels (“Prudential Backstop” or “Calendar Provisioning”) on all the non-performing exposures, originated as of 26 April 2019. The two drivers underlying the application of the calendar scheduling are the date of classification as default (vintage) and the type of the underlying collateral, if any (i.e. NPE secured, according to the type of collateral, or unsecured).
The CRR, as amended by the Backstop Regulation, foresees that if the specific credit risk adjustments (plus other items listed in Article 47c(1) are not sufficient compared to prudential minimum loss coverage, such difference should be directly deducted from CET1 capital, according to Article 36(1)(m).
On the other hand, each exposure also generates capital absorptions deriving from the RWAs related to the credit risk. These capital absorptions affect institutions’ own funds regardless the adopted approach (e.g. IRB, Standard).
Within this overall framework, it has to be pointed out that institutions under the Standardised approach are allowed to take into account the deduction pursuant to Article 36( 1) (m) in the calculation of both the RWAs, calculated as per Article 111 of the CRR, and the risk weight to be assigned to unsecured non-performing exposures, calculated as per Article 127 CRR. Moreover, for such institutions under the Standardised approach, Article 113 CRR foresees to avoid any double counting between the amount included in the own funds’ deduction and the one included in RWAs calculation.
As regards credit institutions applying the IRB approach, it is not explicitly foreseen to consider the deduction as per Article 36( 1) (m) in the calculation of RWAs, since Article 166 CRR has not been amended. However, the provisions set out in Article 151(1) CRR seems to be consistent with the general principle to avoid double counting between the amount included in the own funds’ deduction and the one included in RWAs calculation. In fact, according to Article 151(1) CRR "the risk-weighted exposure amounts for credit risk for exposures belonging to one of the exposure classes referred to in points (a) to (e) and (g) of 147(2) shall, unless deducted from own funds, be calculated in accordance with Sub-section 2 except where those exposures are deducted from Common Equity Tier 1 items, Additional Tier 1 items or Tier 2 items."
Therefore, it is not clear how credit institutions applying the IRB approach should consider the interrelation between the Pillar 1 capital requirements for credit risk and the deduction for insufficient coverage for non-performing exposures related to the same exposure.
Example (for illustrative purposes): assuming a secured non-performing exposure with 5-year vintage having a gross exposure value of 100, a capital absorption for credit risk equal to 8 (hp: RW of 100% and an absorption of 8%), specific credit risk adjustments of 30. The regulatory expectation will be 35 (35% of the gross exposure value) and the related deduction will be 5 (resulting from the difference between the expectation of 35 and the specific credit risk adjustments performed on the exposure equal to 30).
In this example, the institution should be impacted both from the deduction of 5 and the capital absorption of 8. Given that the bank has already accumulated capital for 8 to afford credit risk related to the exposure, the capital absorption of 8 could be taken into account when the institution calculated the distance from the expectation. In doing so, the deduction as per Article 36(1)(m), should be equal to 0 (resulting from the difference between the expectation of 35 and the sum of both the specific credit risk adjustments performed on the exposure equal to 30 and the capital absorption of 8).
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