Response to cP on Guidelines on Credit Risk Mitigation for institutions applying the IRB approach with own estimates of LGDs
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Swedbank entities in the Baltic countries have received a number of portfolio guarantees from eligible unfunded credit protection providers (e.g. EIF) under the EU funding programs supporting the financing of SME customers and considers them to be eligible. Swedbank is of the opinion that all requirements in CRR regarding eligibility are fulfilled.
Do they include cases where the guarantee contract sets a materiality threshold on portfolio losses below or above which no payment shall be made by the guarantor? Do they include cases where two or more thresholds (caps) either expressed in percentages or in currency units are set to limit the maximum obligation under the guarantee?
The portfolio guarantees received by Swedbank entities in Baltic countries include two thresholds (caps) expressed in percentages, namely: (1) guarantee rate; and (2) cap rate.
For example, in case the guarantee rate is set at 80 % and the cap rate is set at 25 %, the capped portfolio guarantee covers credit losses up to 80 % (i.e. the guarantee rate) per individual exposure in the portfolio as long as the losses in the pre-defined/pre-agreed portfolio do not exceed 25 % (i.e. the cap rate).
How do you recognise the portfolio guarantees’ credit risk mitigation effects in adjusting risk parameters?
Swedbank does not recognise portfolio guarantees’ credit risk mitigation effects either in adjusting risk parameters or through applying the securitisation framework.
For exposures under the F-IRB approach, when calculating the capital requirement, the portfolio guarantee with two thresholds (caps) could be taken into account using a proportional cover technique when recognising the credit risk mitigation. The credit protection could be recognised on the secured portion (or on 20 % as in the example above) of each of the exposure in the pre-defined/pre-agreed portfolio instead of using the securitisation framework.
Thus, as illustrated in the example above, in case the guarantee rate is set at 80 % and the cap rate is set at 25 %, the portion of the aggregated exposure of the portfolio which is covered by the capped portfolio guarantee is equal to 20 % (i.e. guarantee rate * cap rate = coverage rate that the protection provider has undertaken to pay to the bank in the event of the default or non-payment of the borrower in the portfolio). This effectively means that 20 % of each individual exposure in the portfolio is secured by the portfolio guarantee, while the remaining 80 % of the individual exposure is either unsecured or secured by the other types of collateral.
Regarding securitisation, it is not clear whether all types of capped portfolio guarantees transfer a part of the risk of a loan in one or more tranches, meaning that Article 234 is applicable.
According to the definition in Regulation 2017/2402:
‘securitisation’ means a transaction or scheme, whereby the credit risk associated with an exposure or a pool of exposures is tranched, having all of the following characteristics:
(a) payments in the transaction or scheme are dependent upon the performance of the exposure or of the pool of exposures;
(b) the subordination of tranches determines the distribution of losses during the ongoing life of the transaction or scheme;
‘tranche’ means a contractually established segment of the credit risk associated with an exposure or a pool of exposures, where a position in the segment entails a risk of credit loss greater than or less than a position of the same amount in another segment, without taking account of credit protection provided by third parties directly to the holders of positions in the segment or in other segments;
The portfolio guarantees may not always result in tranches that are contractually established segments and that one segment entails greater risk of credit loss or less than a position of the same amount in another segment.
If the definition of tranche is not fulfilled, then a proportional cover technique as described above could be used. Article 233.1 CRR explains that the value of the unfunded credit protection shall be the amount that the protection provider has undertaken to pay.
For exposures under the A-IRB approach, an internal portfolio guarantee acceptance methodology could be used to recognise the portfolio guarantee with two thresholds (caps) when calculating the capital requirement; this would compare the credit risk protection characteristics of the portfolio guarantee to the characteristics of the individual guarantees’ population used in the modelling of the respective internal LGD estimate. If the risk protection characteristics of the portfolio guarantee satisfy the acceptance criteria (i.e. are comparable and representative to the individual guarantees population used in the modelling), the internally modelled LGD estimate could be applied on the whole exposure in the portfolio covered by the portfolio guarantee program.
For exposures under F-IRB and A-IRB approaches, in case of an SA guarantor providing portfolio guarantee, Swedbank would also support the option to apply the risk weight of the guarantor for the secured portion of each exposure in the portfolio covered by the portfolio guarantee program.
Against the background of the EU funding programs supporting the financing of SME customers through the provision of portfolio guarantees to credit institutions, in particular, and considering the complexity associated with securitisation for a retail bank, Swedbank considers it important that the credit risk mitigation effects of portfolio guarantees can be recognised through other methods than applying the securitisation framework.
Question 1: Do you agree with the proposed clarifications on eligibility requirements in accordance with Article 181(1)(f) of the CRR?
NoQuestion 2: Do you agree with the proposed clarifications on the assessment of legal certainty of movable physical collateral? How do you currently perform the assessment of legal effectiveness and enforceability for movable physical collateral?
NoQuestion 2: Do you agree with the proposed clarifications on the assessment of legal certainty of movable physical collateral? How do you currently perform the assessment of legal effectiveness and enforceability for movable physical collateral?
NoQuestion 4: Do you have specific concerns related to the recognition of collateral in the modelling of LGD? How do you currently recognise collateral in your LGD estimates?
NoQuestion 5: What approaches for the recognition of the unfunded credit protection do you currently use? What challenges would there be in applying approaches listed above for the recognition of unfunded credit protection?
NAQuestion 6: Do you have any specific concerns related to the issues excluded from the scope of the Guidelines?
NAQuestion 7: Do you agree with the proposed clarification regarding the parallel treatment of ineligible UFCP and ineligible FCP? How do you currently monitor the cash flows related to ineligible unfunded credit protection and how do you treat such cash flows with regard to the PD and LGD estimates?
NAQuestion 8: Do you agree with the proposed rules for the application of the substitution approach? Do you see any operational limitations in excluding the guaranteed part of exposure to which substitution approach is applied from the scope of application of the LGD model for unguaranteed exposures?
NAQuestion 9: Do you agree with the proposed rules for the application of the modelling approach?
NAQuestion 10: What challenges would you envisage for back-testing the substitution approach? Do you agree that the back-testing should be performed rather at Expected loss level? Do you have any approach currently in place for the back-testing of substitution approach?
NAQuestion 11: Do you agree with the proposed guidance for the estimation of the LGD of comparable direct exposure towards the guarantor? What concerns would you have about the calculation of the risk weight floor?
NAQuestion 12: Do you consider portfolio guarantees as a form of eligible UFCP? Do they include cases where the guarantee contract sets a materiality threshold on portfolio losses below or above which no payment shall be made by the guarantor? Do they include cases where two or more thresholds (caps) either expressed in percentages or in currency units are set to limit the maximum obligation under the guarantee? How do you recognise the portfolio guarantees’ credit risk mitigation effects in adjusting risk parameters?
Do you consider portfolio guarantees as a form of eligible unfunded credit protection?Swedbank entities in the Baltic countries have received a number of portfolio guarantees from eligible unfunded credit protection providers (e.g. EIF) under the EU funding programs supporting the financing of SME customers and considers them to be eligible. Swedbank is of the opinion that all requirements in CRR regarding eligibility are fulfilled.
Do they include cases where the guarantee contract sets a materiality threshold on portfolio losses below or above which no payment shall be made by the guarantor? Do they include cases where two or more thresholds (caps) either expressed in percentages or in currency units are set to limit the maximum obligation under the guarantee?
The portfolio guarantees received by Swedbank entities in Baltic countries include two thresholds (caps) expressed in percentages, namely: (1) guarantee rate; and (2) cap rate.
For example, in case the guarantee rate is set at 80 % and the cap rate is set at 25 %, the capped portfolio guarantee covers credit losses up to 80 % (i.e. the guarantee rate) per individual exposure in the portfolio as long as the losses in the pre-defined/pre-agreed portfolio do not exceed 25 % (i.e. the cap rate).
How do you recognise the portfolio guarantees’ credit risk mitigation effects in adjusting risk parameters?
Swedbank does not recognise portfolio guarantees’ credit risk mitigation effects either in adjusting risk parameters or through applying the securitisation framework.
For exposures under the F-IRB approach, when calculating the capital requirement, the portfolio guarantee with two thresholds (caps) could be taken into account using a proportional cover technique when recognising the credit risk mitigation. The credit protection could be recognised on the secured portion (or on 20 % as in the example above) of each of the exposure in the pre-defined/pre-agreed portfolio instead of using the securitisation framework.
Thus, as illustrated in the example above, in case the guarantee rate is set at 80 % and the cap rate is set at 25 %, the portion of the aggregated exposure of the portfolio which is covered by the capped portfolio guarantee is equal to 20 % (i.e. guarantee rate * cap rate = coverage rate that the protection provider has undertaken to pay to the bank in the event of the default or non-payment of the borrower in the portfolio). This effectively means that 20 % of each individual exposure in the portfolio is secured by the portfolio guarantee, while the remaining 80 % of the individual exposure is either unsecured or secured by the other types of collateral.
Regarding securitisation, it is not clear whether all types of capped portfolio guarantees transfer a part of the risk of a loan in one or more tranches, meaning that Article 234 is applicable.
According to the definition in Regulation 2017/2402:
‘securitisation’ means a transaction or scheme, whereby the credit risk associated with an exposure or a pool of exposures is tranched, having all of the following characteristics:
(a) payments in the transaction or scheme are dependent upon the performance of the exposure or of the pool of exposures;
(b) the subordination of tranches determines the distribution of losses during the ongoing life of the transaction or scheme;
‘tranche’ means a contractually established segment of the credit risk associated with an exposure or a pool of exposures, where a position in the segment entails a risk of credit loss greater than or less than a position of the same amount in another segment, without taking account of credit protection provided by third parties directly to the holders of positions in the segment or in other segments;
The portfolio guarantees may not always result in tranches that are contractually established segments and that one segment entails greater risk of credit loss or less than a position of the same amount in another segment.
If the definition of tranche is not fulfilled, then a proportional cover technique as described above could be used. Article 233.1 CRR explains that the value of the unfunded credit protection shall be the amount that the protection provider has undertaken to pay.
For exposures under the A-IRB approach, an internal portfolio guarantee acceptance methodology could be used to recognise the portfolio guarantee with two thresholds (caps) when calculating the capital requirement; this would compare the credit risk protection characteristics of the portfolio guarantee to the characteristics of the individual guarantees’ population used in the modelling of the respective internal LGD estimate. If the risk protection characteristics of the portfolio guarantee satisfy the acceptance criteria (i.e. are comparable and representative to the individual guarantees population used in the modelling), the internally modelled LGD estimate could be applied on the whole exposure in the portfolio covered by the portfolio guarantee program.
For exposures under F-IRB and A-IRB approaches, in case of an SA guarantor providing portfolio guarantee, Swedbank would also support the option to apply the risk weight of the guarantor for the secured portion of each exposure in the portfolio covered by the portfolio guarantee program.
Against the background of the EU funding programs supporting the financing of SME customers through the provision of portfolio guarantees to credit institutions, in particular, and considering the complexity associated with securitisation for a retail bank, Swedbank considers it important that the credit risk mitigation effects of portfolio guarantees can be recognised through other methods than applying the securitisation framework.