Response to consultation on draft Regulatory Technical Standards on materiality threshold of credit obligation past due

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Q2. Do you agree with the proposed maximum levels of the thresholds?

In Article 2(3) of the draft RTS, EBA proposes an absolute threshold of 200 euros for retail exposures and 500 euros for all other exposures. A relative threshold is to amount to a maximum of 2% of the total amount of all credit obligations of the borrower to the credit institution. Taking into account the expected impacts listed under Q5, the EFBS advocates the retention of a relative threshold of 2.5% which is already applied in some Member States.

Q3. How much time is necessary to implement the threshold set by the competent authority according to this proposed draft RTS? Given current practices, what is the scope of work required to achieve compliance?

According to article 2(1) of the draft RTS the national supervisory authorities should on basis of the EBA provisions set a threshold for all institutions in the respective Member State. Due to the transposition of these supervisory requirements the credit institutions will be subject to various adaptations in their operative systems. The workload for the institutions will naturally be dependent on the option chosen by the EBA under Q1. If the definition of default is amended, it is expected that implementation work will take one to two years for IRBA institutions. In particular, the following steps would be necessary which are presented in detail again under Q5:
- implementation of the amended definition of default in the production systems: three to nine months;
- adjustment of the identification of default in the historical data: four to eight weeks;
- impact assessment of the amended definition of default; massive changes to the historical default rate are expected especially for retail institutions: two to four weeks;
- complete redesign of all scorecards for the probability of default (PD) and the loss given default (LGD): four to nine months;
- repeat of the IRBA authorisation process, since an amendment to the definition of default brings about a material change to the assessment procedures: three to six months.
For institutions that use the standardised approach there will be at least the adjustment of the identification of default and corresponding consideration in the internal management, as well as impact assessments.

Q4. Do you agree with the assessment of costs and benefits of these proposed draft RTS?

So far, the EBA has undertaken only a qualitative analysis of the proposed changes. It becomes clear from its explanations that the benefits of a change to the definition of default are limited in comparison with the expected costs. This is already shown by the length of the passages which the EBA has devoted to the respective explanations: four lines of comments on the benefits on page 30 and 1.5 pages of comments on the costs on pages 29 and 30.
The EFBS lists as benefits easier comparability of the thresholds by the European supervisory authority and the harmonised procedure when determining obligor default by cross-border credit institutions. The EFBS gets the impression that the focus of the paper is definitely on the latter, whereas the national supervisory authorities and the credit institutions which will continue to report to them in the future too are unable to draw any significant benefit from the RTS, but will be heavily burdened by implementation costs. As the EBA correctly states on page 15 in the explanatory text on question 3, the operational impact is substantial especially for IRBA institutions. This also applies for credit institutions that have applied to use the IBR approach pursuant to Article 143 CRR. The uncertainties they will experience in the application procedure as a result of the change in the definition of default are not however dealt with in the EBA paper.
There is no quantitative cost estimate yet in the EBA paper. The limits finally set by EBA are nevertheless decisive for the national supervisory authorities in determining the thresholds. If when analysing the specifications an imbalance arises at national level between the benefits of changing the definition of default and the associated costs, only limited room for action remains for the national authorities. They would not succeed in creating an excess of the benefit of the new regulation over the costs.
For this reason, the EFBS considers it essential for a quantitative impact assessment to be carried out before the thresholds are definitively determined by the EBA.

Q5. What is the expected impact of these proposed draft RTS?

The EFBS expects substantial conversion efforts to arise for institutions if the definition of default is amended, especially in the following fields:
- The institutions must draw up time-consuming, costly impact assessments on the new definition of default. This is the case especially for IRBA institutions. However, this is likely to apply to a limited extent for the institutions that use the standardised approach as well, since on account of the resulting higher frequency of default, they must make adaptations with regard to provision for risks and risk-bearing capacity.
- By tightening up the default criteria, the probability of default would rise. In the event of amendment of the definition of default, also an interaction between PD and LGD could develop. Thus, the large number of artificial defaults caused, could allow LGD to decrease. Since however own estimates of loss given default for collateral in the form of property under the IRBA may not be lower than the limits of 10% and 15% respectively provided for in Article 164(4) and (5) CRR, a significant increase in the expected loss relevant for provision for risks is to be counted on, especially for credit institutions specialising in business secured by residential property, such as notably the Bausparkassen. An offsetting effect of “increasing PD against reducing LGD” is possible only to a limited extent as a result of the lower limit. We are asking EBA to consider this consequence in its remarks on the impacts of the materiality threshold on the possible default and thus the calculation of expected loss (EL) and own funds requirements.
- What the expected impacts will be on provision for risks and risk-bearing capacity and, in the case of IRBA institutions, on the calculation of the expected loss and necessary capital adequacy requirements depends on the portfolio of each individual institution. However, it is in any case certain that in individual institutions massive additional own funds requirements will arise.
- The EFBS is expecting a decisive impact on the estimates of risk parameters. The time-consuming and costly steps to be carried out by IRBA institutions and IRBA applicants in the context of the development of estimation processes must be repeated on the basis of the new definition of default. New parameter estimation processes must be developed.
- The estimation processes newly developed by the IRBA institutions must again be subject to the inspection for use of the IRB approach by the competent authorities in accordance with Article 144 CRR. The costs invested are on the same scale as the costs of the initial inspection for use of the IRBA. In addition, the delay in the completion of the inspection prior to the grant of authorisation also gives rise to additional costs for IRBA applicants.

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Name of organisation

European Federation of Building Societies