Article 170 4(c) of the CRR requires considering the ‘delinquency’ risk driver when assigning exposures to grades or pools, ‘except where an institution demonstrates to the satisfaction of its competent authority that delinquency is not a material driver of risk for the exposure’. The consideration of this type of information is also reflected in paragraph 57 of the EBA/GL/2017/16 (‘behavioural information, including delinquency and the use of credit facilities’). At the same time, Article 46 of CDR 2022/439 requires competent authorities to verify certain aspects of the PD estimation method, among them the functional and structural form of the estimation method, the cyclicality of the estimation method and the choice of risk drivers. As regards cyclicality, recital 22 of CDR 2022/439 specifies that ‘With regard to risk quantification, it is desirable that the PD estimates are relatively stable over time in order to avoid the excessive cyclicality of own funds requirements’. The consideration of delinquency drivers is key to ensure an adequate risk differentiation in the structure of a rating system, as otherwise obligors not meeting their contractual instalments may not be penalized in terms of credit quality. However, such a driver is generally correlated with the economic cycle (i.e., during distressed economic periods it is expected that there will be more delinquent obligors) and so its consideration may, in the absent of an appropriate calibration technique, lead to cyclicality in que quantification of own funds requirements. The EBA/GL/2017/16 recognise the fact that Entities should understand their rating philosophy (clearly influenced by the choice of risk drivers) and the need to choose an appropriate calibration philosophy in order to reach ‘the objectives behind the chosen calibration and re-calibration process and methodology’. In addition, EBA/GL/2017/16 describe different alternatives in the ‘Background and rationale section’ that may be compliant options provided all regulatory requirements are satisfied.

Against this background, the consideration of highly relevant risk drivers, like ‘delinquency’, and the desire to avoid excessive cyclicality of own funds requirements may be reconciled by the choice of an appropriate calibration technique, consistent with a calibration philosophy pursuing the stability of capital requirements under varying economic circumstances. However, this may entail frequent re-calibrations of the grade level PDs if economic circumstances change. An example of this is given in the ‘Background and rationale’ section of EBA/GL/2017/16: ‘An institution might use a more complex combination, for example by using risk drivers that are quite sensitive to economic conditions in a statistical default prediction model providing PD estimates for individual obligors, (i.e. a PIT rating philosophy), but applying a two-step approach for the purpose of calibration, namely by evaluating these PD estimates on a more recent point in time and subsequently adjusting them such that the average of these estimates reflects the long-run average default rate at the level of the relevant calibration segment (or even portfolio – if there is only one calibration segment)’. The change of economic circumstances would entail the need to select a more recent point in time calibration sample to evaluate PD estimates and, if necessary, adjust PDs accordingly. The need for recalibration of PDs when economic circumstances change, due to the chosen rating philosophy, is the appropriate solution under a point in time rating philosophy. This aspect may be underpinned by the regular (minimum) annual reviews of the risk estimates, in which it can be evaluated whether the outputs of the model are in line with the rating and calibration philosophies chosen by the institutions. In case divergences, arise, estimates should be adjusted.