Article 181(1)(a) of Regulations (EU) No 575/2013 (CRR) specifies that LGDs shall be estimated on the basis of the average realized LGD by facility grade or pool using all observed defaults.
According to point 55 of Article 4(1) of Regulations (EU) No 575/2013 (CRR) ‘Loss given default’ or ‘LGD’ means the ratio of the loss on an exposure due to the default of a counterparty to the amount outstanding at default.
For the purpose of calculating the realized LGD, how should the amount outstanding at default (and the denominator of LGD) be calculated for exposures in scope of Article 166 (10) of Regulations (EU) No 575/2013 (CRR) that are fully off-balance at the moment of default?
For exposures for which own conversion factor estimates can be used (exposures specified in Article 166 (8)) the conversion factor estimate should reflect drawings up to and after the time a default event is triggered. To align the outstanding at default amount used in the conversion factor estimate with the denominator of the realized LGD, the denominator of the realized LGD should also include additional drawings after the time the default event is triggered. This is described in paragraphs 140 and 141 of EBA/GL/2017/16.
Note that EBA paragraphs 140 and 141 are only relevant for products for which own estimates of conversion factors are used. No specifications are provided by EBA on how to treat additional drawings related to products in scope of CRR article 166 (10).
For the purpose of calculating the realized LGD for exposures in scope of Article 166 (10) of Regulations (EU) No 575/2013 (CRR) that are fully off-balance at the moment of default, but come on balance during the default period, the following options can be considered to calculate the denominator of the realized LGD:
In the context of option 4, the drawn part of a commitment refers to the amount to which a credit facility to provide off-balance sheet products to an obligor has been used by the obligor.
To illustrate these options an explicit example is provided.
Suppose an institution provides to a customer a facility to provide bank guarantees. The customer can draw guarantees under this facility up to a pre-specified limit of 100. The original maturity of the facility is more than one year. Suppose for simplicity that this facility is the only product offered to the customer. Suppose further that the borrower defaults and at the moment of default, guarantees up to an amount of 50 have been drawn by the customer and no guarantees have yet been claimed by the beneficiaries of those guarantees up to the default moment. During the default period a guarantee in the amount of 25 is claimed by the beneficiary of that guarantees.
In this example, the on-balance exposure at the default moment is zero and, for the purpose of calculating the realized LGD, the denominator of the realized LGD would be calculated under the four options described above as: