Response to cP on Guidelines on Credit Risk Mitigation for institutions applying the IRB approach with own estimates of LGDs
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Furthermore, the substitution approach has shortcomings in the handling of certain types of guarantee. The methods described for UFCP essentially only assume forms of guarantee that take effect prior to the realisation of material collateral. Thus, forms of UFCP such as residual value insurances, which are applied from an economic point of view after considering the realisation of funded credit protection (FCP), are not sufficiently taken into account. The partial exposure for such guarantees cannot be modelled appropriately. The same applies to the risk weight floor.
The separate risk weight function for the substitution approach indicated in the explanatory box for consultation purposes (page 36, third bullet point) shows different treatment compared to the modelling approach and the adjustment of grades, pools or LGD estimates. In this case, a recomposition of the exposure and corresponding key figures might be a more suitable method.
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?
Within the framework of the substitution approach for unfunded credit protection (UFCP), institutions are to be able to split the exposures in two separate parts if they are only partially hedged by an UFCP (page 38). In our opinion, it should be clarified whether this splitting of the exposures should only be presented and tracked in the mathematical derivations, e.g. in model documentation or also by corresponding data sets in data processing systems. The same applies to the risk weight floor.Furthermore, the substitution approach has shortcomings in the handling of certain types of guarantee. The methods described for UFCP essentially only assume forms of guarantee that take effect prior to the realisation of material collateral. Thus, forms of UFCP such as residual value insurances, which are applied from an economic point of view after considering the realisation of funded credit protection (FCP), are not sufficiently taken into account. The partial exposure for such guarantees cannot be modelled appropriately. The same applies to the risk weight floor.
The separate risk weight function for the substitution approach indicated in the explanatory box for consultation purposes (page 36, third bullet point) shows different treatment compared to the modelling approach and the adjustment of grades, pools or LGD estimates. In this case, a recomposition of the exposure and corresponding key figures might be a more suitable method.
Question 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?
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GBIC_position paper_EBA CP CRM.pdf
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