CP10 (Full Document) - European Banking Authority

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200. Institutions must collect and store data to assess LGDs, including realised LGDs, recovery and workout costs. This information should be collected at the level of each defaulted exposure or each pool (when necessary in the retail exposure class). Over time, institutions are expected to collect workout costs at as granular level as possible. If institutions only have data at an aggregate level, they should develop a proper allocation methodology. Use of external data of economic loss 201. The less internal information the institution has for estimating LGDs (also in terms of representativeness of the defaulted portfolio), the more important is the use of external data (including pooled data) and multiple data sources (e.g., the combination of external and internal data) for improving robustness of LGD parameter estimation. In particular, appropriate external benchmarks, if available, should be considered by the institution. The institution should carefully evaluate all relevant external data and benchmarks, as some data on components of loss are typically countryspecific (for example, the potential inability to gain control over collateral depends on national legal frameworks) or institutionspecific data (for example, collection processes leading to variations in workout costs, other direct costs, and indirect costs). In other cases, some components of economic loss might not be included in the external data. The institutions should analyze the loss components of the external data and the comparability of external data with respect to its lending practices and internal processes, and should take into account the results of these analyses during the estimation process. (See also section 3.4.4. on data sources). Discount rate 202. The discount rates used by institutions to incorporate material discount effects into economic loss may vary depending on the respective market, the kind of facility, or the institution’s workout practices for defaulted facilities. The choice of discount rates may also depend on whether they are being used to calculate realised LGDs or estimated LGDs. Material changes that impact discount effects (such as when the situation changes between the (past) time when LGDs are realised and the (present) time when they are estimated) require another discount rate to be used for estimated cash flows. Such material changes must be taken into account when estimating the LGDs used in the riskweight function. 203. Discount rates used for the calculation of the ’best estimate‘ of expected loss for defaulted exposures – which should take into account ‘ current economic conditions, and, therefore, the current level of discount factors – could also be different from those used to calculate realised LGD or estimated LGD’s . 204. Institutions should demonstrate that: Page 48 of 123
· Their discounting method results in appropriate discount rates that take into account the nature of exposure or obligors and are not lower than an appropriate riskfree rate chosen by the institution. An institution which uses a riskfree rate should demonstrate that any remaining risk is covered elsewhere in the calculation. For example, uncertainty of cash flows may be covered in the numerator. · Their process for arriving at a discount rate is consistent for all exposures of the same kind. Institutions should justify this point carefully, to ensure the absence of any arbitrage caused by manipulating discount factors. Allocation of direct and indirect costs 205. Workout and collection costs should include the costs of running the institution’s collection and workout department, the costs of outsourced services, and an appropriate percentage of other ongoing costs, such as corporate overhead. 206. An institution should demonstrate that it collects in its databases all information required to calculate material direct and indirect costs. The costallocation process is expected to be based on the same principles and techniques that institutions use in their own cost accounting systems. These might include (among others) methods based on broad averages, or statistical methods based on appropriately chosen samples within a population of defaulted obligors. Institutions should demonstrate that the costallocation process is sufficiently relevant and rigorous. Institutions should also define ‘materiality’ and document the cost elements and the aggregate amounts of cost elements which they did not take into account as material costs. 3.3.3. Rating systems and risk quantification 3.3.3.1. Probability of Default (PD) 207. The first parameter used in the supervisory formula for calculating regulatory capital requirements for credit risk is the Probability of Default. According to the CRD, IRB institutions are expected to have rating systems which: · Assign obligor/exposure risk ratings and validate the accuracy of those ratings (Annex VII, Part 4, Paragraphs 5 to 31). · Translate risk ratings into IRB parameters, specifically for estimating probabilities of default (Annex VII, Part 4, Paragraphs 31, 4972). Rating Assignment methodology Page 49 of 123
Page 1 and 2: CEBS CP 10 11 July 2005 Guidelines
Page 3 and 4: ANNEXES ...........................
Page 5 and 6: to use these approaches. 6. The gui
Page 7 and 8: IRB approach can be given only if t
Page 9 and 10: approaches for regulatory purposes
Page 11 and 12: purposes, when the group has submit
Page 13 and 14: efficient running of the process, u
Page 15 and 16: and/or 105 of the CRD, subject to t
Page 17 and 18: 58. Institutions intending to move
Page 19 and 20: translated, supervisors will organi
Page 21 and 22: 76. The issues that supervisors are
Page 23 and 24: holding company, the competent auth
Page 25 and 26: · A new approval process shall not
Page 27 and 28: · Institutions may not be ready to
Page 29 and 30: 2. Asking institutions to notify su
Page 31 and 32: 116. ‘Immaterial’ should refer
Page 33 and 34: 128. The EU Council has proposed th
Page 35 and 36: should start with inputs, and those
Page 37 and 38: to be only broadly compliant with t
Page 39 and 40: institutions to be able to identify
Page 41 and 42: differentiated if their loss rates
Page 43 and 44: payments are originating from the s
Page 45 and 46: any of its subsidiaries in full, wi
Page 47: 197. As a general rule, the rating
Page 51 and 52: grades. In this case, all of the re
Page 53 and 54: of challenges, including choosing t
Page 55 and 56: 228. In principle, supervisors do n
Page 57 and 58: prices on defaulted exposures, and
Page 59 and 60: LGD estimation, they have to be tak
Page 61 and 62: The exposure value for the followin
Page 63 and 64: investigating the potential drivers
Page 65 and 66: advisable in some circumstances not
Page 67 and 68: terms) the proof of consistency wit
Page 69 and 70: 302. The information used in credit
Page 71 and 72: exposures to obligors or facilities
Page 73 and 74: Pooled data sets for good predictiv
Page 75 and 76: inputs to the IRB approach. Supervi
Page 77 and 78: used to quantify the risk parameter
Page 79 and 80: years for the economy as a whole, a
Page 81 and 82: · Institutions must be able to bri
Page 83 and 84: Benchmarking the outputs of interna
Page 85 and 86: model, and the internal use of the
Page 87 and 88: systems” (Annex VII, Part 4, Para
Page 89 and 90: · Examining reports from Internal
Page 91 and 92: organisational point of view (e.g.,
Page 93 and 94: conclusions are wellfounded. Inte
Page 95 and 96: 401. The role played by the CRC fun
Page 97 and 98: subsidiary, or by different subsidi
Page 99 and 100:
way of a formal notification). The
Page 101 and 102:
· The rollout plan should have a
Page 103 and 104:
Principles and examples 1. The purp
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etween systems, recording of data t
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· The definition of an appropriate
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incorporate forwardlooking elemen
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· Approving proactive risk managem
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frequency and format of the interna
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· Development of internal processe
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· Understanding the extent and nat
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‣ If not, inform the other superv
Page 121 and 122:
the decision. ‣ Agree on the proc
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