CP10 (Full Document) - European Banking Authority

197. As a general rule, the rating assignment process and the definition of
default adopted should be consistent. For example, if a rating is
assigned to the entire group to which the individual borrowing entity
belongs (e.g., if it is based on the consolidated balance sheet, and
the ‘rated entity’ is thus the group), then the default status should
be triggered accordingly (i.e., for the whole group as a single rating
object), unless the subsidiary is clearly legally ‘bankruptcy remote’ in
the respective jurisdiction(s). In that case, however, supervisors
might question whether a group rating was appropriate.
3.3.2.2. Definition of loss
198. The CRD defines loss and Loss Given Default (LGD) in Article 4,
sections 26 and 27, and dedicates a specific section to the
requirements specific to own LGD estimates. The definitions are
based on the concept of economic loss (Article 4, section 26), which
includes material discount effects and material direct and indirect
costs associated with collecting on the instrument. This is a broader
concept than accounting measures of loss. The economic loss
associated with an exposure can be quantified by comparing the
amount outstanding at the time of default with the economic value
that can be recovered from the exposure (e.g., possible recoveries
diminished by material work­out costs). Further drawings must be
taken into account at the loss level if they are not included in the
exposure at default. Recoveries, losses, and costs are to be
discounted back to the time of default for determining economic
losses.
Data for economic loss
199. The Loss Given Default (LGD) is the ratio of the loss on an exposure
due to the default of a counterparty to the amount outstanding at
default. (Article 4(27)). The data used to calculate the realised LGD
of an exposure must include all relevant information. This should
include, depending on the type of the exposure:
· The outstanding amount of the exposure 12 at the time of default
(including principal plus unpaid but capitalized interest and fees);
· Recoveries, including the income and sources of recoveries (e.g.,
cash flows from sale of collateral and guarantees proceeds or
realised income after sale of defaulted loans).
· Work­out costs, including material direct and indirect costs
associated with work­out collection such as the cost of running
the institution’s work­out department, the costs of outsourced
collection services directly attributable to recoveries such as legal
costs, and also an appropriate percentage of other ongoing costs
such as corporate overheads.
· The dates and the amounts of the various cash flows that were
incurred (‘timing of the recovery process’).
12 For the different possibilities for calculating exposure values, see Annex VII, Part 3.
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