Article 181
Requirements specific to own-LGD estimates
1.
In quantifying the risk parameters to be associated with rating grades or pools, institutions shall apply the following requirements specific to own-LGD estimates:
(a)
institutions shall estimate LGDs by facility grade or pool on the basis of the average realised LGDs by facility grade or pool using all observed defaults within the data sources (default weighted average);
(b)
institutions shall use LGD estimates that are appropriate for an economic downturn if those are more conservative than the long-run average. To the extent a rating system is expected to deliver realised LGDs at a constant level by grade or pool over time, institutions shall make adjustments to their estimates of risk parameters by grade or pool to limit the capital impact of an economic downturn;
(c)
an institution shall consider the extent of any dependence between, on the one hand, the risk of the obligor and, on the other hand, that of funded credit protection, other than master netting agreements and on-balance-sheet netting of loans and deposits, or its provider;
(d)
currency mismatches between the underlying obligation and the funded credit protection other than master netting agreements and on-balance-sheet netting of loans and deposits shall be treated conservatively in the institution’s assessment of LGD;
(e)
to the extent that LGD estimates take into account the existence of funded credit protection other than master netting agreements and on-balance-sheet netting of loans and deposits, those estimates shall not solely be based on the estimated market value of the funded credit protection;
(f)
to the extent that LGD estimates take into account the existence of funded credit protection other than master netting agreements and on-balance-sheet netting of loans and deposits, institutions shall establish internal requirements for the management, legal certainty and risk management of that funded credit protection, and those requirements shall be generally consistent with those set out in Chapter 4, Section 3, Sub-section 1;
(g)
to the extent that an institution recognises funded credit protection other than master netting agreements and on-balance-sheet netting of loans and deposits for determining the exposure value for counterparty credit risk in accordance with Chapter 6, Section 5 or 6, any amount expected to be recovered from that funded credit protection shall not be taken into account in the LGD estimates;
(h)
for the specific case of exposures already in default, the institution shall use the sum of its best estimate of expected loss for each exposure given current economic circumstances and exposure status and its estimate of the increase of loss rate caused by possible additional unexpected losses during the recovery period, i.e. between date of default and final liquidation of the exposure;
(i)
to the extent that fees for late payments, imposed on the obligor before the time of default, have been capitalised in the institution’s income statement, they shall be added to the institution's measure of exposure and loss;
(j)
for exposures to corporates, institutions, central governments and central banks, and regional governments, local authorities and public sector entities, estimates of LGD shall be based on data over a minimum of five years, increasing by one year each year after implementation until a minimum of seven years is reached, for at least one data source, if the available observation period spans a longer period for any source, and the data are relevant, that longer period shall be used.
For the purposes of the first subparagraph, point (a), of this paragraph institutions shall adequately take into account recoveries realised in the course of the relevant recovery processes from any type of funded credit protection as well as from unfunded credit protection not falling under the definition in Article 142(1), point (10).
For the purposes of the first subparagraph, point (c), cases where there is a significant degree of dependence shall be addressed in a conservative manner.
For the purposes of the first subparagraph, point (e), LGD estimates shall take into account the effect of the potential inability of institutions to expeditiously gain control of their collateral and liquidate it.
2.
For retail exposures, institutions may do the following:
(b)
reflect future drawings either in their conversion factors or in their LGD estimates;
(c)
For purchased retail receivables use external and internal reference data to estimate LGDs.
For the purposes of the first subparagraph, point (b), where institutions include future additional drawings in their conversion factors, those should be taken into account in the LGD in both the numerator and the denominator. Where institutions do not include future additional drawings in their conversion factors, those should be taken into account in the LGD numerator only.
For retail exposures, estimates of LGD shall be based on data over a minimum of five years. Subject to the permission of the competent authorities, institutions may use, when they implement the IRB Approach, relevant data covering a period of two years. The period to be covered shall be increased by one year each year until relevant data cover at least five years.
3.
EBA shall develop draft regulatory technical standards to specify the following:
(a)
the nature, severity and duration of an economic downturn referred to in paragraph 1;
(b)
the conditions according to which a competent authority may permit an institution pursuant to paragraph 2 to use relevant data covering a period of two years when the institution implements the IRB Approach.
EBA shall submit those draft regulatory technical standards to the Commission by 31 December 2014.
Power is delegated to the Commission to adopt the regulatory technical standards referred to in the first subparagraph in accordance with Articles 10 to 14 of Regulation (EU) No 1093/2010.
4.
EBA shall issue guidelines, in accordance with Article 16 of Regulation (EU) No 1093/2010, to clarify the treatment of any type of funded credit protection and unfunded credit protection for the purposes of paragraph 1, point (a), of this Article and for the purposes of the application of the LGD parameters.
5.
For the purpose of calculating loss, EBA shall, by 31 December 2025, issue updated guidelines, in accordance with Article 16 of Regulation (EU) No 1093/2010, on the following:
(a)
with regard to cases that return to non-defaulted status, specifying how artificial cash flow is to be treated and whether it is more appropriate for institutions to discount the artificial cash flow over the actual period of default;