CP10 (Full Document) - European Banking Authority

institution’s databases at as granular a level as possible. The raw
data for calculating loss originate in the collection department (for
example, recoveries, realisation of collateral, and all cash flows), the
accounting department (unpaid but capitalised interest, amount
outstanding at the time of default), or other departments. Many
institutions using an Internal Rating Based approach record these
raw data in a financial data warehouse. All information needed to
calculate economic loss must be collected. No filters should be
applied at this stage. The data warehouse may feed a database of
observed cash­flows which is used to calculate economic loss.
Realised LGDs are ex­post values that can be applied to a facility
grade or pool.
218. The institution assigns estimated LGDs to its current facilities (both
defaulted and non­defaulted) and uses them to calculate the capital
requirements for its exposures. Estimated LGDs are based on the
realised LGDs for the applicable Reference Data Set (RDS). However,
estimated LGDs are likely to differ from the average realised LGDs in
the RDS because the former needs to incorporate expectations of
future recovery rates. This involves calculating a long­run forwardlooking
recovery rate for the facility grade or pool, taking both
current and future economic circumstances into account. The
institution should produce an LGD estimate appropriate for an
economic downturn (‘Downturn LGD’) if this is more conservative
than the long­run average. Other adjustments may also be
necessary. In practice, institutions may adjust either the
measurement of the realised LGD or the estimation of the final LGDs.
219. For defaulted exposures, an institution must also produce a best
estimate of expected loss given current economic circumstances and
exposure status. The difference between this amount and the
estimated LGD derived from the RDS stems from the possibility of
additional losses during the recovery period, and represents the
Unexpected Loss capital requirement for the defaulted exposure.
High level principles
220. LGD estimates should reflect the experience and practices of the
individual institution as well as the external environment in which it
operates. One consequence of this is that institutions cannot rely on
industry­wide estimates without adjusting them to reflect their own
position.
221. Since a given percentage variation in LGD estimates results in an
equal percentage change in capital charges, any approximation
and/or shortcut that the institution decides to adopt should form an
important aspect of validation and assessment.
Data
222. A key step in estimating any IRB parameter is preparing the
Reference Data Set (RDS) for that parameter. This involves a variety
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