The European Banking Authority (EBA) published today its final draft Regulatory Technical Standards (RTS) on the conditions for competent authorities (CAs) to grant permission for institutions to use relevant data covering shorter time series (data waiver permission), when estimating risk parameters. These RTS will be part of the Single Rulebook in the banking sector in the European Union (EU).
When using the Internal-Ratings-Based approach (IRB) to estimate risk parameters such as the probability of default (PD), the loss given default (LGD) and the conversion factor (CF), institutions may ask Competent Authorities (CAs) to use shorter data series, namely data covering a period of minimum two years instead of the required five years.
Data waiver was initially permitted in the EU legal framework to promote the use of internal models. Following an impact assessment, the EBA concluded that most major EU financial institutions had already been using the IRB Approach for several years, and that there were likely to be only a few new data waiver requests arising from new IRB applications, hence making the data waiver less relevant. The EBA also concluded that using a shorter data history increases the uncertainty of risk parameter estimates and as then introduced specific conditions for the use of the data waiver, in order to limit the potential implications on the calculation of own funds requirements.
In particular, the EBA is proposing to introduce some conditions that would exclude from the waiver low-default portfolios and limit its application to a small proportion of assets. In order to further mitigate the risks associated with shorter data series, the proposed RTS also highlight the importance of applying an appropriate margin of conservatism to parameter estimates, as well as ensuring an enhanced data vetting process. Finally, institutions should be able to prove that relevant datasets covering longer time series are not available if that is the case.
These RTS ensure the application of proportionality principles, as well as legal clarity. In this respect, the EBA has concluded that the provisions of these RTS should apply only to new data waiver permissions to be granted by the CAs.
The proposed draft RTS have been developed on the basis of Regulation of Regulation (EU) 575/2013 (Capital Requirements Regulation – CRR). The EBA must submit these draft RTS to the European Commission for endorsement by 31 December 2014.