CP10 (Full Document) - European Banking Authority

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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 Page 52 of 123
of challenges, including choosing the sample size, the length of time series, reliance on external data, the treatment of defaulted positions that have generated no loss, and the length of recovery processes (incomplete workout). The RDS for LGD should contain at least the following elements: · Unlike the RDS for PD estimation, it should include only exposures to defaulted obligors; · It should include factors that can be used to group the defaulted facilities in meaningful ways; 223. Ideally, it should: · Cover a period that is sufficiently long to include at least one business cycle; · Contain all defaults that have occurred within the considered time frame; · Contain data for calculating realised LGDs; · Include all relevant information needed to estimate the risk parameters; · Include data on the relevant drivers of loss. 224. The institution must ensure that the RDS remains representative of its current portfolios. The RDS should therefore be updated when necessary (see Annex VII, Part 4, Paragraph 50). 225. Some defaulted positions may generate no loss, or may even have positive outcomes in the recovery process. The treatment of these events should be take into account the following: · A clear distinction must be made between realised LGDs and estimated LGDs as a parameter for calculating risk weighted exposure amounts. The realised LGD might be zero: if an exposure is cured with no material direct or indirect cost associated with collecting on the instrument, and no loss caused by material discount effects (for example, if the default was caused solely by the 90 day pastdue criterion, and payment obligations were subsequently completely fulfilled), no loss might occur. · In cases of low or zero estimated LGD, institutions must demonstrate that their estimation processes are pertinent and accurate. In particular, they should be able to provide concrete evidence of all factors taken into account in the quantification process that gave rise to the low estimates, such as the discount rate, the estimated value of the collateral, the structure of the cash flows, etc. · Even if positive outcomes in the recovery processes have been observed and can be explained, the estimated LGD used to calculate capital requirements must not be less than zero. It may be zero in exceptional cases. Institutions should demonstrate Page 53 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 and 48: 197. As a general rule, the rating
Page 49 and 50: · Their discounting method results
Page 51: grades. In this case, all of the re
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
Page 105 and 106:
etween systems, recording of data t
Page 107 and 108:
· The definition of an appropriate
Page 109 and 110:
incorporate forwardlooking elemen
Page 111 and 112:
· Approving proactive risk managem
Page 113 and 114:
frequency and format of the interna
Page 115 and 116:
· Development of internal processe
Page 117 and 118:
· Understanding the extent and nat
Page 119 and 120:
‣ If not, inform the other superv
Page 121 and 122:
the decision. ‣ Agree on the proc
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