Effectiveness of supervision is overall good, the EBA Peer Review Report on the definition of default finds

The European Banking Authority (EBA) today published a Peer Review on its Guidelines on the application of the definition of default.  The Review found that the effectiveness of supervision in this area is good, in particular as regards the monitoring of internal ratings-based approach (IRBA) credit institutions. Supervision of the definition of default of credit institutions using the standardised approach (SA) is also good but more varied, reflecting the more dispersed nature of credit institutions and the relative predominance of IRBA credit institutions in terms of size and assets in different jurisdictions. The Report identifies a small number of follow-up measures/recommendations for certain competent authorities as well as best practices that would be of benefit for other competent authorities to adopt.

In the aftermath of the global financial crisis a harmonised definition of default was established in the EU as a key component in higher-quality and more uniform assessment of credit risk and calculation of risk-weighted assets, reducing the scope for regulatory arbitrage. The EBA was mandated to issue guidelines harmonising the definition of default of an obligor that is used for the purpose of the internal ratings-based approach for the calculation of capital requirements for credit risk as well as for the standardised approach.

The Report includes findings on the supervision of credit risk of six competent authorities, focusing on application of the definition of default and the EBA Guidelines across three major areas:

• implementation of the EBA Guidelines  in the supervisory framework;

• effectiveness of the procedure for the submission of the application;

• effectiveness of the assessment for checking compliance with the definition of default. 

While some EU IRBA banks are under the supervision of a national competent authority (in conjunction with the European Central Bank - ECB), the majority are under the direct supervision of the ECB. The ECB has developed a detailed and thorough approach towards definition of default supervision, including documentation for the submission of definition of default applications. Regarding the  supervision of the definition of default of credit institutions using the standardised approach, the Review has identified scope for additional consideration by competent authorities, alongside best practices to further strengthen supervision. These include: 

• considering and documenting the elements used to determine the basis of risk-based supervision of the definition of default and/or the supervisory review and evaluation process (SREP) assessments;

• potential alignment of self-assessment questionnaires on the definition of default submitted to banks;

• consideration of the appropriate frequency and depth of assessments;

• establishing minimum checks on IT systems used by credit institutions to calculate elements of the definition of default;

• alignment of remedial actions in the context of local versus cross-border institutions. 

Legal basis and background

Article 30 of the EBA Regulation requires the EBA to periodically conduct peer reviews of some or all of the activities of competent authorities within its remit, to further strengthen consistency and effectiveness in supervisory outcomes. Peer reviews identify follow-up measures to achieve this, together with best practices seen in competent authorities. After two years, the EBA is required to assess the adequacy and effectiveness of actions taken by competent authorities in response to the follow-up measures.

The Peer Review has been performed by an ad hoc Peer Review Committee made up of EBA and competent authorities’ staff in accordance with the EBA peer review work plan for 2023-2024 and following the process in Article 30 of the EBA Regulation and EBA peer review methodology.

The exercise covered six competent authorities (ECB/SSM, Greece, Liechtenstein, Poland, Sweden and Slovenia). The competent authorities were selected on the basis of objective criteria: Five competent authorities (GR, PL, LI, SE and SI) were selected based on the average percentage of non-performing loans (NPLs) in institutions’ banking book within their jurisdiction, i.e. two competent authorities with the average highest percentage of NPLs ratio, two competent authorities with the lowest percentage of NPLs ratio and one competent authority with an NPL ratio which is at the median of the distribution of the various European countries). The ECB/SSM was included in the sample given the breadth of credit institutions under its supervision.