Response to consultation on Guidelines for the estimation of LGD appropriate for an economic downturn

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Question 1: Do you think that additional guidance around the estimation of LGD in-default, which reflect downturn conditions, is needed? If yes, could you provide examples of sound methodologies for transposing downturn LGD estimates from performing to non-performing exposures?

Yes, ESBG believes it would be good to include writing similar to the one proposed on LGD in de-fault, i.e. that same downturn component may be utilised to downturn adjust LGD in default esti-mates.

Additional guidance would also be appreciated on open statements like “sufficiently severe” in Arti-cle 3 in DT GD or in paragraph 22 on LGD GD impact analysis (i) elevated realised LGDs; (ii) de-creased annual recoveries; (iii) decreased number of facilities returned to non-defaulted status; or (iv) prolonged time in default.

Question 2: Do you share the concern that the proposed policy in paragraph 15 could create an undue burden if applied to every downturn period identified? If yes, in order to better balance the accuracy of the estimations and its operational complexity what evidence should be provided by institutions in order to justify the exemption of identified downturn periods from the proposed policy in paragraph 15?

In ESBG’s view, to reduce the operational burden, a simplified approach would be to compare loss data with the relevant economic factors. If losses do not increase as a result of economic factors indi-cating a downturn period, even if introducing an appropriate time lag, that should be enough evidence to exempt the identified downturn period from the proposed policy in paragraph 15.

Question 3: Do you agree with the proposed level of downturn LGD estimation set out in paragraph 14? In particular, do you support the concept that the downturn LGD estimates of different calibration segments could be based on different downturn periods? Is the policy on the level of downturn LGD estimation as well as the relation between the level of downturn LGD estimation and the relevant downturn periods sufficiently clear?

ESBG would like to stress that it is not clear on which level downturn conditions should be identi-fied, moreover we believe that this may cause undue variation. In our view, it will be more beneficial from a capital planning point of view to have fewer grades or pools, although from a steering point of view this could potentially drive risk. If estimates shall be based on the worst observed crises, then the more granular you get in estimation the less you may benefit from diversification effects, i.e. the granularity level of estimates may have a significant impact on DT estimates.

Question 4: Do you consider the description of the approaches to be sufficiently clear?

Yes, ESBG considers the description of the approaches to be sufficiently clear.

Question 5: Do you agree to the limitation of approaches for quantification of downturn LGD estimates? If not, which other approaches should be considered? Would you prefer the alternative policy considered – if yes how should a minimum MoC be established in this case?

Yes. However, ESBG sees a potential driver of undue variation in adapting external time series to internal ones. In particular, variations may be significant due to how discounting (5 % add-on) and time in default is accounted for in external data. Therefore, competent authorities have an important responsibility in ensuring there is a level playing field across banks.

Question 6: Do you expect that the total exposure amount or share which is treated with the policy proposed in Section 7 is material?

It is impossible to answer the question as it is unclear when supervisory authorities will find extrapo-lation methods non-applicable. Given a strict interpretation and reliance on data from 1990s this may be a large share of non-retail portfolios.

Question 7: Do you have specific examples of types of exposures which will fall under the policy proposed in Section 7?

ESBG believes that corporate exposures not secured by real estate may fall within this category.

Question 8: Do you agree to require a minimum MoC quantified via a fixed add-on to the long-run average LGD? If not, which of the alternatives should be considered? Do you see reasons for differentiating the fixed add-on according to exposure classes?

ESBG would suggest a QIS to detect possible differences between different exposure classes, type of collaterals and geographical region (i.e. legislation). We think it should not be beneficial to use add-on but neither should it result in a bank being punished for having to use MoC due to the fact that it has not experienced a crisis during recent years.

It should be noted that lending values as inputs are already geared to the long term. This also applies to other categories of collateral. Of course the 20% should also cover reduced recovery rates and re-duced contributions in a recession, but we still think 20% is too high.

Question 9: Do you agree to the minimum MoC as the max(0,min(20%, 105% - LRAVLGD)?

ESBG would suggest a QIS to see if 20% unit add-on is feasible, see Q8.

Name of organisation

European Savings and Retail Banking Group (ESBG)