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Response to consultation on Guidelines on the application of the definition of default
Go back1. Do you agree with the proposed definition of technical defaults? Do you believe that other situations should be included in this definition? If yes, please provide detailed proposals on how to address further possible situations.
The rationale for allowing institutions to ignore technical defaults gives them leeway to stop upgrading their IT systems. If technical defaults lead to the burden to increase capital requirements, it would be an incentive to get their internal organisation in order. I thus do not support this loophole for excluding own fault technical defaults from the ‘default’ treatment.2. Do you consider the requirements on the treatment of factoring arrangements as appropriate and sufficiently clear? If not, please provide proposals for additional clarifications.
I support a separate regime for factoring. An anti-abuse provision might, however, be opportune.3. Do you agree with the approach proposed for the treatment of specific credit risk adjustments?
The indicators appear to lack clear external financial market indicators, and equally appear to refer to rather late indicators (e.g. indicators that only need to be looked at when accounting obligations occur). This means that the build up of additional capital is likely to be late, instead of forward looking. When large/systemic obligors such as countries or banks fail, any of the facts that you refer to as indicators will likely build up fast, and should thus also be monitored much more frequently (and acted upon with speed by the institution). The main rule of Art. 178 paragraph 1 of the CRR does not appear to allow such a leisurely approach as envisaged in the indicators mentioned in your consultation paper (even though the examples in the later paragraphs of that article appear to be lacking in any rigour). A better approach would be to research what the best indicators for unlikelihood to pay for non-debt assets that are normally included in the credit risk calculation would be. Think of rising CSD values, or ongoing or rapid decreases in the value of shares or bonds issued by the counterparty (see below and in the attached blog).4. Do you consider the proposed treatment of the sale of credit obligations appropriate for the purpose of identification of default?
If either relatively substantial losses at sale or fair value adjustments occur, all exposures to the obligor should be reassessed for unlikelihood to pay. This to avoid abuse/avoidance by the bank involved, who now can label it as a regular sale even if larger losses are incurred. Phrasing the requirement in a manner that only binds the bank if it actually officially determines that the loss is ‘credit-related’ gives an opportunity to abuse this guidance (by failing to make such a formal assessment, the bank avoids the follow up under your guidance).5. Do you agree that expected cash flows before and after distressed restructuring should be discounted with the customer’s original effective interest rate or would you prefer to use the effective interest rate applicable at the moment before signing the restructuring arrangement? Do you consider the specification of the interest rate used for discounting of cash flows sufficiently clear?
No comment.6. Do you agree that the purchase or origination of a financial asset at a material discount should be treated as an indication of unlikeliness to pay?
Yes, definitely. Other indicators of unlikeliness to pay should be included, especially based on very specific financial market indicators, such as a specific percentage of loss in value of shares in an obligor, an increase in interest rates on its traded bonds, an increase in CDS premiums. Such indicators can be derived from the experience in the various stages of the subprime crisis, specifically when large banks were starting to fail and when sovereigns were starting to fail. In addition: Pulling or treatment of all obligations of a single name obligor is now too lenient towards the bank. If one obligation is in default, it should at a minimum count as a strong indicator that all due obligations are in default too, and as a reasonably strong indicator that the obligor is unlikely to pay for not yet due obligations. Having to default all exposures only if ‘a significant part’ of all obligations is troubled leaves the build up of capital by increasing capital requirements too late, and open for abuse. If the intent is truly to be forward looking in building up financial buffers, the indicators should be plentiful and stringently applied.7. What probation periods before the return from default to non-defaulted status would you consider appropriate for different exposure classes and for distressed restructuring and all other indications of default?
The guidelines on the return to non-defaulted status do not appear to consider their impact on delaying the return of larger obligors (especially systemically important obligors) to non-defaulted status. They appear to ignore financial market indicators that a specific listed obligor (e.g. a bank or a sovereign) is no longer considered to be in default by financial markets or the relevant recipients of collateral that is issued by defaulted obligors (e.g. Greece bonds accepted as collateral by the ECB). There is no clarity on whether supervisors can jointly issue guidelines on how to treat obligations of specific systemically relevant obligors, or of obligations of systemically relevant large numbers of small obligors, leaving regulatory forbearance and non-compliance to individual banks and supervisors, and leaving them open to accusations of intentionally undercapitalising the bank in question.8. Do you agree with the proposed approach as regards the level of application of the definition of default for retail exposures?
No comment.9. Do you consider that where the obligor is defaulted on a significant part of its exposures this indicates the unlikeliness to pay of the remaining credit obligations of this obligor?
See the answer to question 6.10. Do you agree with the approach proposed for the application of materiality threshold to joint credit obligations?
No comment.11. Do you agree with the requirements on internal governance for banks that use the IRB Approach?
No comment.Name of organisation
Prudential Supervision
