Response to consultation on Guidelines on proportionate retail diversification methods

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Q1. What is the percentage of exposures within your retail portfolio that are part of a group of connected clients?

LOPI has carried out a questionnaire survey among our 29 members with a retail portfolio of less than EUR 500mn, which mirrors EBA’s corresponding consultation, in order to get a clearer picture of the impact of the diversification test on smaller institutions.

LOPI has received input from 19 member institutions. To address the consultations questions 1, 4, and 5, the institutions' individual calculations are provided in the attached document.

 

About LOPI (The Association of Local Banks, Savings Banks and Cooperative Banks in Denmark)

Lokale Pengeinstitutter/LOPI (The Association of Local Banks, Savings Banks and Cooperative Banks in Denmark) is an association of 43​​​​ local banks, savings banks and cooperative banks in Denmark, The Faroe Islands, and Greenland. The members include practically all the Danish local banks with a distinctive local presence.

Q2. Do you identify any implementation issue in implementing the diversification method?

LOPI’s response to Question 2

EBA proposes a highly disproportionate method for retail diversification where a portfolio of retail exposures of EUR 500mn or more is considered by definition as diversified and therefore can be granted the 75% risk weight whereas a portfolio of retail exposures of less than EUR 500mn is subjected to a diversification test which may result in the entire portfolio or parts of it being assigned a risk weight of 100%. 

For smaller institutions, EBA’s Guidelines on the diversification of the retail portfolio may lead to a significant increase in the capital requirement for the retail portfolio.

As a result, LOPI has carried out a questionnaire survey among our 29 members with a retail portfolio of less than EUR 500mn, which mirrors EBA’s corresponding consultation, in order to get a clearer picture of the impact of the diversification test on smaller institutions. The feedback shows that especially the iterative 10% approach has a significant impact on the smallest institutions, but approach 2 also has a considerable effect on the smallest institutions. 

For eight of the association's smallest members, the iterative 10% method results in the entire retail portfolio being moved from a risk weight of 75% to a risk weight of 100%, whereas the non-iterative 5% method for the same institutions moves between 47% and 82% of the retail portfolio from a risk weight of 75% to a risk weight of 100%.

Regarding the capital impact, one of the institutions reports that the iterative 10% method reduces the total capital ratio by 4.3 percentage points, while the non-iterative 5% method reduces the total capital ratio by 2.8 percentage points.

As outlined below under the headline "Attachment (EBA GL on diversification – consequences" the capital impact of the two diversification approaches is inversely correlated with the size of the retail portfolio, meaning a smaller portfolio is relatively most affected. For an elaboration of this conclusion, please consult the data from our questionnaire survey among small financial institutions, which are also attached to this consultation response.

As we elaborate below, a number of smaller institutions are unfairly affected by the diversification method proposed by the EBA – even with a significant adjustment of the threshold values suggested by the EBA. Therefore, for these institutions, there is a need to base the diversification test on an alternative and more qualitative approach in dialogue with the national competent authority.

LOPI’s opinion:

The diversification method proposed by EBA is highly disproportionate, as the diversification test only includes the retail portfolio of smaller institutions, while the retail portfolio of larger institutions is considered by definition as diversified and can be granted a risk weight of 75%.

Furthermore, among the included retail portfolios of up to EUR 500mn, the method proposed by EBA results in the capital impact of the two diversification methods being inversely correlated with the size of the retail portfolio, thereby having a high impact on smaller institutions.

Thereby, the diversification method proposed by EBA does not ensure a level playing field between the financial institutions and reduces the competitive strength of the smaller institutions.

Smaller institutions under the Standardised approach (SA)- are already operating under higher risk weights than IRB institutions for otherwise identical exposures. With EBA’s draft Guidelines, the risk weights are further increased for the smallest institutions, which face a 33% (25 percentage points) increase in capital charge on the entire or parts of the retail portfolio.

In addition to an increasing capital requirement, it will also prove more difficult for the smaller institutions to price products for retail customers, as the capital requirement for a given exposure can increase by 33% (25 percentage points) if there are changes in the composition or volume of the retail exposures of the institution.

Smaller institutions are important for the local communities and are characterized by a simple business model, which do not impose any risk for overall financial stability.

The diversification method proposed by EBA is mechanical and not risk-based and should in LOPI’s opinion be rethought and rewritten, as the basis for assessing diversification in the current draft Guidelines in the form of the 0.2% threshold results in an inherent disproportionality, which the supplementary thresholds of 5% and 10% cannot correct.

If the EBA chooses to maintain a mechanical approach, it is crucial that the iterative method is removed and that only the non-iterative method is retained while simultaneously increasing the established threshold values significantly. The threshold of 0.2%, which Basel has modeled based on large banks, should, in an EU context, be significantly increased to at least 0.5% to reflect the fact that the banking sector in the EU comprises a large number of smaller financial institutions that are disproportionately affected by the diversification method proposed by the EBA.

The 0.2% threshold corresponds, for our smallest member, to an amount of just 29,000 euros, which results in a significant portion of the retail portfolio (approximately 80%) exceeding the threshold and being transferred to the supplementary calculation. For several other of our small members, the 0.2% threshold similarly corresponds to small amounts, leading to a significant portion of the retail portfolio exceeding the threshold and being moved into the supplementary calculation.

The size of a retail exposure does not decrease in proportion to the size of the institution, as, for example, the cost of a car is the same outside cities as in cities meaning a car loan will be of the same size regardless of the institution's size and geographical location. To account for this, the threshold of 0.2% must – as stated – be significantly increased to at least 0.5%. Alternatively, the threshold value of 0.2% can be maintained but combined with a rule stating that retail exposures of less than 200,000 euros are considered diversified, regardless of whether the exposures exceed the 0.2% threshold.

Regardless of whether the threshold value of 0.2% is increased significantly to at least 0.5% or maintained at 0.2% and combined with a monetary limit, as proposed in our alternative suggestion, the change must be accompanied by an increase in the supplementary threshold value of 5% in the non-iterative method to a minimum threshold value of 20%. This adjustment is necessary to mitigate the adverse effects of the proposed diversification method, which significantly reduces the competitiveness of smaller institutions.

Despite the substantial increase in threshold values in the non-iterative method, as suggested above, some small institutions would still be unfairly affected by a mechanically determined diversification method, leading to a noticeable impact on their total capital ratio. A sensitivity analysis we conducted for the smallest institutions shows that, almost regardless of how much we adjust the threshold values in the EBA proposal (the 0.2% threshold and the 5% threshold in the non-iterative method), these small institutions—within a realistic range of adjustments to the EBA-proposed thresholds—would still be unreasonably affected.

To address this issue, it is necessary to supplement the mechanical non-iterative approach – with the adjustments we propose above – with an alternative approach. This alternative approach would allow a financial institution that is unreasonably affected by the mechanical non-iterative diversification method to instead, following prior agreement with the national competent authorities, base the diversification test on an assessment of its retail portfolio using criteria set by the financial institution, the national authorities, or the EBA. These criteria would imply a solution where the diversification requirement can be met via more qualitative tests and descriptions of the diversification in the retail portfolio. The financial institution’s assessment of its retail portfolio would then be submitted to the national authorities, which would determine whether all or part of the retail portfolio can be considered diversified.

Attachment (EBA GL on diversification – consequences)  

As it can be seen from the figures below, the capital impact of the two diversification approaches is inversely correlated with the size of the retail portfolio, meaning a smaller portfolio is relatively most affected (where the indicated percentages are linked to the development of the exposure value before risk weighting of the retail exposure portfolio under the two diversification approaches):

Institute 1 (retail exposures: EUR 14 mn)

  • Approach 1 (iterative ”10% approach”) leads the entire retail exposure portfolio from a risk weight of 75% to a risk weight of 100%.
  • Approach 2 (non-iterative ”5% approach”) leads 82% of the retail exposure portfolio from a risk weight of 75% to a risk weight of 100%.

Institute 2 (retail exposures: EUR 22mn)

  • Approach 1 (iterative ”10% approach”) leads the entire retail exposure portfolio from a risk weight of 75% to a risk weight of 100%.
  • Approach 2 (non-iterative ”5% approach”) (also) leads 82% of the retail exposure portfolio from a risk weight of 75% to a risk weight of 100%.

Institute 3 (retail exposures: EUR 25mn)

  • Approach 1 (iterative ”10% approach”) leads the entire retail exposure portfolio from a risk weight of 75% to a risk weight of 100%.
  • Approach 2 (non-iterative ”5% approach”) leads 65% of the retail exposure portfolio from a risk weight of 75% to a risk weight of 100%.

Institute 4 (retail exposures: EUR 32mn)

  • Approach 1 (iterative ”10% approach”) leads the entire retail exposure portfolio from a risk weight of 75% to a risk weight of 100%.
  • Approach 2 (non-iterative ”5% approach”) leads 61% of the retail exposure portfolio from a risk weight of 75% to a risk weight of 100%.

Institute 5 (retail exposures: EUR 38mn)

  • Approach 1 (iterative ”10% approach”) leads the entire retail exposure portfolio from a risk weight of 75% to a risk weight of 100%.
  • Approach 2 (non-iterative ”5% approach”) leads 57% of the retail exposure portfolio from a risk weight of 75% to a risk weight of 100%.

Institute 6 (retail exposures: (also) EUR 38mn)

  • Approach 1 (iterative ”10% approach”) leads the entire retail exposure portfolio from a risk weight of 75% to a risk weight of 100%.
  • Approach 2 (non-iterative ”5% approach”) leads 47% of the retail exposure portfolio from a risk weight of 75% to a risk weight of 100%.

Institute 7 (retail exposures: EUR 51mn)

  • Approach 1 (iterative ”10% approach”) leads the entire retail exposure portfolio from a risk weight of 75% to a risk weight of 100%.
  • Approach 2 (non-iterative ”5% approach”) leads 49% of the retail exposure portfolio from a risk weight of 75% to a risk weight of 100%.

Institute 8 (retail exposures:  EUR 59mn)

  • Approach 1 (iterative ”10% approach”) leads the entire retail exposure portfolio from a risk weight of 75% to a risk weight of 100%.
  • Approach 2 (non-iterative ”5% approach”) leads 66% of the retail exposure portfolio from a risk weight of 75% to a risk weight of 100%.

Institute 9 (retail exposures: EUR 68mn)

  • Approach 1 (iterative ”10% approach”) leads 89% of the retail exposure portfolio from a risk weight of 75% to a risk weight of 100%.
  • Approach 2 (non-iterative ”5% approach”) leads 20% of the retail exposure portfolio from a risk weight of 75% to a risk weight of 100%.

Institute 10 (retail exposures: EUR 78mn)

  • Approach 1 (iterative ”10% approach”) leads 47% of the retail exposure portfolio from a risk weight of 75% to a risk weight of 100%.
  • Approach 2 (non-iterative ”5% approach”) leads 35% of the retail exposure portfolio from a risk weight of 75% to a risk weight of 100%.

Institute 11 (retail exposures: EUR 83mn)

  • Approach 1 (iterative ”10% approach”) leads 59% of the retail exposure portfolio from a risk weight of 75% to a risk weight of 100%.
  • Approach 2 (non-iterative ”5% approach”) leads 35% of the retail exposure portfolio from a risk weight of 75% to a risk weight of 100%.

Institute 12 (retail exposures: EUR 113mn)

  • Approach 1 (iterative ”10% approach”) leads 20% of the retail exposure portfolio from a risk weight of 75% to a risk weight of 100%.
  • Approach 2 (non-iterative ”5% approach”) leads 24% of the retail exposure portfolio from a risk weight of 75% to a risk weight of 100%.

Institute 13 (retail exposures: (also) EUR 113mn)

  • Approach 1 (iterative ”10% approach”) leads 17% of the retail exposure portfolio from a risk weight of 75% to a risk weight of 100%.
  • Approach 2 (non-iterative ”5% approach”) leads 6% of the retail exposure portfolio from a risk weight of 75% to a risk weight of 100%.

Institute 14 (retail exposures: EUR 168mn)

  • Approach 1 (iterative ”10% approach”) leads 46% of the retail exposure portfolio from a risk weight of 75% to a risk weight of 100%.
  • Approach 2 (non-iterative ”5% approach”) leads 31% of the retail exposure portfolio from a risk weight of 75% to a risk weight of 100%.

Institute 15 (retail exposures: EUR 174mn)

  • Approach 1 (iterative ”10% approach”) leads 28% of the retail exposure portfolio from a risk weight of 75% to a risk weight of 100%.
  • Approach 2 (non-iterative ”5% approach”) leads 16% of the retail exposure portfolio from a risk weight of 75% to a risk weight of 100%.

Institute 16 (retail exposures: EUR 246mn)

  • Approach 1 (iterative ”10% approach”) leads 27% of the retail exposure portfolio from a risk weight of 75% to a risk weight of 100%.
  • Approach 2 (non-iterative ”5% approach”) leads 18% of the retail exposure portfolio from a risk weight of 75% to a risk weight of 100%.

Institute 17 (retail exposures: EUR 258mn)

  • Approach 1 (iterative ”10% approach”) leads 5% of the retail exposure portfolio from a risk weight of 75% to a risk weight of 100%.
  • Approach 2 (non-iterative ”5% approach”) leads 11% of the retail exposure portfolio from a risk weight of 75% to a risk weight of 100%.

Institute 18 (retail exposures: EUR 359mn)

  • Approach 1 (iterative ”10% approach”) leads 0% (zero) of the retail exposure portfolio from a risk weight of 75% to a risk weight of 100%.
  • Approach 2 (non-iterative ”5% approach”) leads 3% of the retail exposure portfolio from a risk weight of 75% to a risk weight of 100%.

Institute 19 (retail exposures: EUR 387mn)

  • Approach 1 (iterative ”10% approach”) leads 0% (zero) of the retail exposure portfolio from a risk weight of 75% to a risk weight of 100%.
  • Approach 2 (non-iterative ”5% approach”) leads 0% (zero) of the retail exposure portfolio from a risk weight of 75% to a risk weight of 100%.

Q3. Which methods do you currently use to assess retail diversification? Please elaborate.

The majority of the 19 LOPI financial institutions that have provided input for this consultation response state that they use the granting process as a benchmark for determining whether an exposure is part of a homogeneous group and therefore can be classified under the exposure category: “retail exposures” with a risk weight of 75%. If an exposure cannot be handled within the institution’s loan approval process for private individuals and small and medium-sized enterprises (retail customers), the exposure is not assigned a risk weight of 75%. As part of their loan approval process for private individuals and small and medium-sized enterprises, financial institutions have set an upper limit for the exposure size, which reflects, among other factors, the institution’s size and business model. Additionally, several financial institutions report that they typically reject customers who fall outside the institution’s loan approval process for private individuals and small and medium-sized enterprises.

Q4. Under the proposed approach, in the first step of the calculation before any exclusion, what is the share in terms of exposure value of the large eligible retail exposures as defined under the proposed approach compared to all the eligible retail exposures?

LOPI has carried out a questionnaire survey among our 29 members with a retail portfolio of less than EUR 500mn, which mirrors EBA’s corresponding consultation, in order to get a clearer picture of the impact of the diversification test on smaller institutions.

LOPI has received input from 19 member institutions. To address the consultations questions 1, 4, and 5, the institutions' individual calculations are provided in the attached document.

 

About LOPI (The Association of Local Banks, Savings Banks and Cooperative Banks in Denmark)

Lokale Pengeinstitutter/LOPI (The Association of Local Banks, Savings Banks and Cooperative Banks in Denmark) is an association of 43​​​​ local banks, savings banks and cooperative banks in Denmark, The Faroe Islands, and Greenland. The members include practically all the Danish local banks with a distinctive local presence.

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LOPI (The Association of Local Banks, Savings Banks and Cooperative Banks in Denmark)