1.   When assessing the method of PD estimation, as referred to in Article 180 of Regulation (EU) No 575/2013, competent authorities shall verify that the one-year default rate for each grade or pool is calculated in a manner consistent with the characteristics of the one-year default rate defined in point 78 of Article 4(1) of Regulation (EU) No 575/2013, and they shall verify that:

(a)	the denominator of the one-year default rate includes the obligors or exposures which, at the beginning of a one year period, are not in default and are assigned to that rating grade or pool;

(b)

the numerator of the one-year default rate includes those of the obligors or exposures referred to in point (a) that have defaulted within that one year period; multiple defaults for the same obligor or exposure, which have been observed during the one year period relating to the default rate, are considered to be a single default as referred to in Article 49(b) having occurred on the date of the first of those multiple defaults.

2.   Competent authorities shall verify that the method of PD estimation by obligor grade or pool is based on the long-run average of one-year default rates.

For that purpose they shall verify that the period used by the institution to estimate the long-run average of one-year default rates is representative of the likely range of variability of default rates for that type of exposures.

3.   Where observed data used for PD estimation are not representative of the likely range of variability of default rates for a type of exposures, competent authorities shall verify that both of the following conditions are met:

(a)	the institution uses an appropriate alternative method for estimating the average of one-year default rates over a period that is representative of the likely range of variability of default rates for that type of exposures;

(b)	an appropriate margin of conservatism is applied where, after applying an appropriate method as referred to in point (a), the estimation of the averages of default rates is found to be unreliable or to have other limitations.

4.   For the purposes of the verification under paragraph 1, competent authorities shall verify that all of the following is appropriate for the type of exposures:

(a)	the functional and structural form of the estimation method;

(b)	assumptions on which the estimation method is based;

(c)	the cyclicality of the estimation method;

(d)	the length of the historical observation period used in accordance with Article 45;

(e)	the margin of conservatism applied in accordance with Article 44;

(f)	the human judgement;

(g)	where applicable, the choice of risk drivers.

5.   For exposures to corporates, institutions, central governments and central banks, where the obligors are highly leveraged or the assets of the obligor are predominantly traded assets as referred to in point (a) of Article 180(1) of Regulation (EU) No 575/2013, competent authorities shall verify that the PD reflects the performance of the underlying assets in the periods of stressed volatility as referred to in that provision.

6.   For exposures to corporates, institutions, central governments and central banks, where the institution makes use of a rating scale of an ECAI, competent authorities shall verify the institution’s analysis of compliance with the requirements laid down in point (f) of Article 180(1) of Regulation (EU) No 575/2013, and check that that analysis addresses the issue of whether the types of exposures rated by the ECAI are representative of the institution’s types of exposures and the time horizon for the credit assessment by the ECAI.

7.   For retail exposures, where the institution derives the estimates of PD or LGD from an estimate of total losses and an appropriate estimate of PD or LGD as referred to in point (d) of Article 180(2) of Regulation (EU) No 575/2013, competent authorities shall verify the institution’s analysis of compliance with all relevant criteria on PD and LGD estimation laid down in Articles 178 to 184 of Regulation (EU) No 575/2013.

8.   For retail exposures, competent authorities shall verify that the institution regularly analyses and takes into account the expected changes of PD over the life of credit exposures (‘seasoning effects’) as referred to in point (f) of Article 180(2) of Regulation (EU) No 575/2013.

9.   In the assessment of statistical models for PD estimation, competent authorities shall, in addition to the methods laid down in paragraphs 1 to 8, apply the methodology for assessing specific requirements for statistical models or other mechanical methods laid down in Articles 37 to 40.