10 March 2020
The European Banking Authority (EBA) published today an Opinion on the treatment of credit insurance in the prudential framework, in response to the extensive feedback received in its public consultations on draft Guidelines on credit risk mitigation for institutions applying the Internal Ratings-Based Approach (IRB Approach) with own estimates of Loss Given Default (LGD). In this Opinion the EBA calls for the implementation of the final Basel III framework as agreed by the Basel Committee on Banking Supervision.
The main concerns raised in the feedback received relate to LGD applied to the exposures to the insurance companies under the IRB Approach without the use of own estimates of LGD, especially in the context of the changes introduced in the final Basel III framework published by the Basel Committee on Banking Supervision (BCBS) in December 2017. These reforms disallow the use of own estimates of LGD for exposures to financial institutions, including insurance companies. As a result, the regulatory values of LGD have to be used also where the effects of credit insurance used as credit risk mitigation is recognised through substitution of risk parameters. This was commented as overly punitive given the higher seniority of claims from policy insurance over other claims towards insurance undertakings.
The analysis presented in the Opinion leads to the conclusion that there should not be a specific value of regulatory LGD for credit insurance claims. While higher seniority typically applies to claims from insurance policies, due to the specific structure of the balance sheets of the insurance undertakings, most of the claims in the unwinding proceedings would benefit from such priority. As a result, in case of failure of an insurance company the insurance policy holders may still suffer from significant losses, especially in the conditions of economic downturn. In particular, there is no evidence that these losses would be significantly lower than the currently applicable regulatory LGD values.
The Opinion points out that the final Basel III framework has been calibrated at the overall level and as such should be implemented in the EU in line with the international agreement. It is also stressed that specifying any preferential treatment for the claims on credit insurance policies would not be compliant with the final Basel III framework.
This Opinion is also submitted to the European Commission to inform its current work on the proposal for the revisions of the Capital Requirements Regulation (Regulation (EU) No 575/2013) in relation to the implementation of the final Basel III framework.
This Opinion has been drafted in accordance with Article 16a and Article 8(1)(a) of Regulation (EU) No 1093/2010. The EBA founding Regulation), which mandates the Authority to contribute to the establishment of high-quality common regulatory and supervisory standards and practices.