The European Banking Authority (EBA) launched today a public consultation on its draft Regulatory Technical Standards (RTS) specifying the nature, severity and duration of an economic downturn according to which institutions shall estimate the downturn loss given default (LGD) and conversion factor (CF). These draft RTS are part of the EBA's broader work on the review of the IRB approach aimed at reducing the unjustified variability in the outcomes of internal models, while preserving the risk sensitivity of capital requirements. The consultation runs until 29 May 2017.
In particular, these draft RTS specify the three conditions - nature, severity and duration - of an economic downturn and propose a methodological approach to identify them. This approach assumes that downturn economic conditions are driven by macroeconomic and credit factors and should be analysed at the level of model components.
In line with the mandate laid down in the Capital Requirements Regulation (CRR), these draft RTS specify a methodological approach to identify the economic downturn conditions, but they do not cover the methods used by institutions to reflect such conditions into downturn LGD and CF estimates. The consultation paper is, therefore, proposing in a separate section a method to be used regarding the LGD parameter as a proposed amendment to the downturn adjustment section of the Guidelines on PD and LGD estimation and the treatment of defaulted assets
Given the relatively high degree of prescriptiveness of the proposed model component approach, which is likely to require substantial resources both from institutions and supervisors when it comes to its implementation, the EBA is also seeking feedback on two simpler alternative approaches to formulate supervisory expectations towards downturn LGD estimation, namely the reference value approach and the supervisory add-on approach.
Considering the material changes that these RTS may require to numerous rating systems currently used by institutions especially for the modelling of downturn LGD and CF, the EBA is proposing to implement these standards by end-2020. This deadline refers to the implementation of all changes stemming from the regulatory review of the IRB approach.
Comments to this consultation can be sent to the EBA by clicking on the "send your comments"
button on the consultation page. Please note that the deadline for the submission of comments is 29 May 2017.
All contributions received will be published following the close of the consultation, unless requested otherwise. A public hearing will then take place at the EBA premises on 4 April 2017 from 14:00 to 16:00 UK time.
Legal basis and next steps
These draft RTS have been developed according to Articles 181(3)(a) and 182(4)(a) of the CRR, which mandate the EBA to specify the nature, severity and duration of an economic downturn according to which institutions shall estimate the downturn LGD and CF.