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ABI - Italian Banking Ass.

Please, refer also to attached document for general comments.

Wording of Section 3.2.2 (first bullet point on page 7) and section 5.1 D c (pages 50-52) seem to suggest that only data or system errors caused by the institution are covered in the definition of technical default as opposed to including data or system errors caused by counterparties.

In the modelling of larger customers it is expected to be rather common that payment delays not caused by financial issues would exceed the materiality threshold. If defaults that are a result of data or system errors of the counterpart are not regarded as technical defaults, modelling of PDs for large corporates will turn into a matter of modelling probability of errors in customer’s data and payment systems. With the strict interpretation of a technical default suggested by EBA, the most relevant risk driver in Large Corporate portfolios would be the size of the company. We believe that payment delays not related to deterioration of the credit quality of the counterparty should not lead to default.

We do not share the view in paragraph 20 that the classification of the obligor to a defaulted status should not be subject to additional expert judgement. Expert judgement has an important place within credit risk management and should continue to be used. Situations may occur that will result in past due exposure of more than 90 days, however not due to a credit deterioration of the counterparty.

For example:

• In leasing business lines, a client could suspend payments not only for a difficulty to reimburse the bank but also for a management decision if a dispute occurs on the leased good (e.g. regarding the quality of goods).
• The same might occur in factoring business. In case of a controversy on a supply, litigation or discussion, the debtor can decide not to pay the invoices, although his creditworthiness is unchanged. This furthermore will often be unknown to the factor and could lead also to damaging contagion effects (please see also our response to question 3 below)
• Commercial dispute on a SBLC (Standby Letter of Credit) would put in default a bank or a large corporate with a potential contagion effect in the case of a syndication of the SBLC (i.e.: all the participating EU banks would place the corporate in default, resulting in a possible limitation of the customer’s access to the credit).
• Call of suretyship where the suretyship contest the legitimacy of the call which entail a past due situation (case of unfair/abusive claim).
• Logistic process issues for Energy & Commodities financing or generally for Trade Finance leading to delays in the delivery. For example, merchandise blocked at the customs, prohibition on entering or leaving ports, strike etc.
• Disputes regarding the amount or the nature of collaterals in case of margin calls.
• As for asset financing long term loans, amendments/waivers or consents are possible due to, for example, a lack of customer responsiveness, maintenance check of products, reality check of the financing according to new market conditions. The expert assessment is essential.
• Specific cases of sovereign counterparts, for which default may be assessed at political level.
• Cases of force majeure (environmental disasters, legally imposed measures, riots, strikes, wars…).
• Payments made by debtors to a factor for certain ceded invoices and not yet registered on the right account due to difficulties in the payment reconciliation process.
• Invoices due but not correctly and promptly dispatched to the debtor by the seller.

Some commercial disputes can last for several months or even years meaning that borrower would stay in default during the whole period. We believe it is important to avoid capturing defaults related to exposures that are disputed or waived or that are not related to the decrease in the quality of the credit risk.

In addition, we strongly ask to underline that in case of a new and wider definition of default (defined among others by way of new and stricter rules on technical default), floors on the minimum level of LGD have to be reviewed or completely removed. In addition, some adjustment will be needed to the general calibration of standardised approaches.

Finally, at least for high default portfolios, we ask to have the possibility of identifying technical defaults on a massive basis rather than on a case-by-case. With regard to the provision in paragraph 19 (requiring to considered “the sum of all amounts past due… for purpose of comparison with the threshold”) we ask to introduce a provision in line with the following:given an obligor that has at least one amount past due more than 90 days, the potential amount in the “less than 15 days past due” bucket can be scratched as an addendum of the above-mentioned sum.
In other words the numerator of the materiality threshold should be limited to the sum of the buckets “more than 15 and less or equal to 90 days past due” and “more than 90 days past due”. Once the amounts migrate from the first to the second and then third bucket there will be no distortion in the past due amount calculation.
Please, refer also to attached document for general comments.

We suggest do add the following sentence after §22: When the factor and the client agree a due date for the credit granted to the client, the counting of days past due shall commence from such date.”

The treatment of exposures to debtors stemming from IAS/IFRS compliant purchased trade debts within a factoring agreement with a client (i.e. where the risks and benefits related with the assigned receivables are fully transferred to the factor and the factor has exposures to the debtors of the client) should take into account that the reliability of the due date of the invoices may be affected by numerous events related to the trade relationship between the buyer and its supplier.

In such cases, a significant delay of the payment may occur without any sign of deterioration of the situation of the debtor. Such situations may originate from contractual provisions or also from informal communication and exchange between the buyer and the supplier.

In such situations, we believe that a relief should be introduced by way of a rebuttable presumption on the automatic classification as past due of trade debtors or of a suspension of days past due counting when the factor is aware of these events, regardless the degree of formality. These occurrences shall however trigger an analysis of the debtor's situation in order to assess possible indications of unlikeliness to pay.

In particular, when the buyer disputes a receivable (e.g. receivables not existing at all or just partially existing, commercial supply not regular or different to the agreements, etc.), the amount or even the very existence of the invoice may be challenged. It is very uncommon that disputes are brought to a court. While disputing parties are usually try to settle the dispute outside the court, the process can nevertheless be time-consuming and exceed the 90 days: therefore a relief should apply whether or not the dispute has been put forward to a court. Indeed, from a risk perspective, disputes, as well as discounts, deductions, netting or in general credit invoices issued by the seller are not in the field of default risk but rather in the field of dilution risk. Hence, that disputes are not a signal of default risk on the debtor and therefore disputed invoices should not be considered past due. Those events should rather be classified within client risk, since they are not covered by credit insurance (and consequently do not represent debtor risk) and since, if they occur, the corresponding amounts are debited from the client account and finally generate client default if they are not reimbursed before 90 days. Therefore, dilution risk should be treated according to art. 230 of the GL10 and not represent a source of default risk on the debtor. The opportunistic use of disputes in order to hide financial difficulties could easily be detected through the analysis of the debtor’s situation triggered by the occurrence of the dispute."
Please, refer also to attached document for general comments.

We agree with the proposal and we underline the importance of having a harmonised application of the definition of default and clear rules for the treatment of SCRA.
Please, refer also to attached document for general comments.

While we agree that selling of a credit obligation resulting in a loss due to fall in credit quality could be an indication of default, we consider the proposed threshold of 5% too low given that even small deterioration in credit rating or changes in interest rate might lead to 5% impact on the market value of an asset. We would therefore recommend to increases the minimum threshold to the level of 10%.
The recent history has proved that when financial markets are highly volatile, some bonds could be under 95% of their par value because the markets anticipate a future decrease of the credit market without the issuer being itself in default. In consequence, the bank may cease granting facilities to the obligor and this could trigger an actual payment default.

Credit obligations could be sold for another reason than the anticipation of a decrease in credit quality of the issuer. A decision to sell participations in loans on performing clients and with a significant loss may be dictated by:

- Regulatory capital savings or employment
- Liquidity management
- Balance sheet management
- Country envelope consumption
- Counterparty exposure management
- Single limit concentration management

A sale price of an asset, which is the fair value, will include other elements besides the credit quality such as liquidity premium; general changes to market conditions, etc and it may not always be straightforward to distinguish which part of the economic loss is related to the deterioration in credit quality. We would therefore suggest to set up objective criteria to identify sales of credit obligations not related to credit risk.

It also has to be taken into account that in case of sales of credit obligations ‘en bloc’, a discount is usually applied compared to one to one evaluation (in order to conclude the deal earlier) with no link to the real risk of the block.
We would propose that the sale of credit obligations is considered as an indication for unlikeliness to pay but should be associated with other indicators and not as a stand-alone criterion.
Furthermore, it is opportune to explicitly identify the different effects of the proposed measures in term of accounting, capital requirements and impact on the estimation of the risk parameters for Institution that use the IRB Approach.

Finally, we would appreciate a clarification by the EBA on whether securitized credits have to be considered within the “sale of credit obligation” category.
Please, refer also to attached document for general comments.

We would advocate the discounting with the “original effective interest rate”, in line with the IFRS 9 (5.4.3).

Considering the 1% threshold for the diminished financial obligation, we believe the threshold is set at a too low level. In our view, the relevant measure for recognition of default should be set at a level, when the new cash flow (NPV) would no longer be adequate to cover the book value of the obligation, regardless of the decline in NPV.

In addition art 178 (3.d) of CRR considers “material forgiveness,…, of principal, interest or, where relevant fees”. The proposed threshold seems not to be consistent with the above mentioned materiality criterion and has therefore to be set at a significantly higher level.

We would also see no need for specifying additional indicators to be considered for identification of default if the net present value of expected cash flows on the distressed restructuring arrangement is higher that the net present value of expected cash flows modifications.

Concerning the formula for calculation of the diminished financial obligation (DO), it is not clear whether the cash flows include the expectation of recovery. If they do not take into account recovery expectation, the threshold would not make much sense as the new restructured loan could include a reinforcement of the collateral value which might mitigate (partially or totally) the diminished financial obligation measured with the proposed formula.

In addition, the formula provides possibility to hide a distressed situation by sufficiently extending maturity and maintaining an equivalent NPV of cash flows. It is also not clear if the two NPV parameters only include the future contractual cash flows or also PD and LGD associated to those cash flows in each moment. In the case of latter, the approach would suffer from a circularity problem. Some restructuring would not be considered as defaulted under the proposed formula for instance when the credit obligation is turned into a PIK loan (payment in kind) with capitalized interest during the period. The proposed formula gives an economic loss of 0.

Finally, we would like to underline that the concept of distressed restructuring does not apply in case a revision of the conditions is allowed by the contract (e.g. embedded clauses) or by specific laws (e.g. moratoria issued by banking association/government) or to commercial renegotiations (e.g. change of interest rate for commercial purposes or alignment with current market practices).
Please, refer also to attached document for general comments.

We agree if CP (paragraph 46 and paragraph 47, letter g) has the same meaning of the IFRS 9, Appendix A “Defined terms” that states “Evidence that a financial asset is credit-impaired include observable data about the following events: (…) f) the purchase or origination of a financial asset at a deep discount that reflects the incurred credit losses”.

If not we disagree. A material discount can be the result of other than financial distress such as general changes to market conditions and a result of negotiations e.g. settling other transactions. Therefore it seems unreasonable that the discount as such should be an indicator of unlikeliness to pay. Such assessment is normally a part of the due diligence of the asset to be bought, to be able to establish a relevant value/price of the asset.

Introduction of rules linking default to the price of purchased (or sold) assets could in effect lead to disincentives for banks to purchase/sell assets at discount to avoid putting its client in default (if a bank already has an exposure to the issuer). This would have negative effect on the role of the banks as intermediaries on the financial markets. Purchased receivables management is an integral part of the banking sector’s activities.

In our view, default should be triggered only for reasons that are directly linked to the credit risk of the counterparty.
Please, refer also to attached document for general comments.

We believe the institutions are best placed to recognize when a customer is no longer in default and we consider the set probation periods inappropriate. Any probation period from default to non-default status is inconsistent with what is set out in Article 178(5) where it is stated that: “If the institution considers that a previously defaulted exposure is such that no trigger of default continues to apply, the institution shall rate the obligor or facility as they would for a non-defaulted exposure.

Also, under IFRS 9 favourable changes in credit risk should be recognised symmetrically with unfavourable changes in credit risk (IFRS 9 BC 5.210). By applying a probation period, financial instruments would move into default quicker than back to non-defaulted status. This can result in exposure being classified as defaulted but not credit impaired under IFRS 9 (bucket 2 exposures) or the exposure would be classified as defaulted and credit impaired (in bucket 3) but with no loan loss allowance which is contra intuitive.

The suggested 3 months’ probation period is considered too long in relation to both large corporate exposures and retail consumers in particular when applied together with the strict definition of the technical default as proposed in the CP. In case of retail and SME customers, payments are not always fully automatized by systematic debit of the customer’s account: a delay in payment does not necessarily mean a deterioration in the credit quality of the borrower especially if the cure period is short (less than 30 days). Delays in payments of large corporates may be caused by systems or data errors. Such defaults would not necessarily mean a deterioration in the credit quality of the borrower especially if the cure period is short (less than 30 days).

We ask that in such cases, counterparties being classified as defaulted could return to non-default status as soon as the obligation is paid in. The three months period should therefore be eliminated as mandatory provision. This is particularly crucial for default trigged by past due. If left unchanged there might be unintended impact on credit risk bureaus and on relationship with costumers registered on them. Customers, specially retail one, will probably not understand and easily accept a rule that marks them as defaulted debtor after the obligation is paid (considering all the related consequences on credit application).

In the final draft of the Guidelines, having regard to Article 59 of the Consultation Paper, it is opportune to specify which repayment suspensions shall be considered as a “grace period”.
In particular, if a restructuring arrangement provides a temporary suspension of the sole interest share of the loan, it is not clear if that suspension shall be treated as a grace period, considering that the principal share of the loan won’t be suspended.

Similarly, should a defaulted client of a bank be bought by another client of the bank (client B) that is not in default, the exposures of the client B should not be considered defaulted if there is no decrease in the credit quality of client B (due to the acquisition). The remaining unlikeliness to pay should be the decisive criteria. Depending on the portfolio specific characteristics, there might be different or no probation periods.
Please, refer also to attached document for general comments.

To summarize our understanding of the proposed guidance:

The guideline confirms that for retail exposure, the financial institution in accordance with second sub-paragraph of Article 178 may apply the definition of default at the individual credit facility level rather than at the obligor level. Furthermore the choice should reflect the financial institution’s internal risk management practice. This may imply that a financial institution in general apply the definition of default at obligor level, but for some specific types of exposure apply it at facility level.

Under IRB the financial institution is required to ensure that the risk estimates correctly reflect the definition of default applied to each type of exposures.

We supports that the credit institution may decide when to apply the default definition at obligor level and/or facility level.

Moreover, we noticed a potential inconsistency regarding the “pulling effect” between this consultation paper and the EBA ITS on forbearance and not performing exposures. Its application seems indeed to be binding in the 2014 EBA standards, while we deem that in the consultation paper its use is discretionary for banks. We ask to eliminate this inconsistency.
Please, refer also to attached document for general comments.

Yes, if the default is credit risk related. We also agree that when an obligor defaults on a significant part of their exposures, the institution should consider this as additional indication of the unlikeliness to pay but it should not automatically indicate the unlikeliness to pay of the remaining credit obligations of this obligor. For example, a mortgage default might result in a higher Probability of Default on other credit obligations but not necessarily the default of them.
Please, refer also to attached document for general comments.

If a joint obligation towards an institution defaults, the individuals taking part in the joint obligations (and their individual obligations, respectively) should not be automatically considered as defaulted. This mechanism is even more problematic when applied to joint obligations consisting of a large number of individuals in which case considering all the individuals involved in the joint obligation automatically as defaulted may not be economically justified at all.

Moreover, the identification of joint fully liability of retail obligors (f.e. married couple) would expose institutions to unbearable burdens especially when this implies ongoing updates of dynamic information (the marital status) difficult to obtain. As a result, we propose to drop article 85.
Please, refer also to attached document for general comments.

We agree. The requirements seems to be in line with CRD IV requirements. It should be ensured however that there is also an alignment with the final Basel Committee Guidelines on credit risk management processed to be applied in accounting for expected credit losses
Claudia Pasquini
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