1.   An institution’s internal methodology, or a part of it, used for estimating default probabilities in accordance with Article 325bp(5), point (e), of Regulation (EU) No 575/2013, shall fulfil the same requirements as those that apply to the methodologies used by institutions that have been permitted to estimate default probabilities in accordance with Part Three, Title II, Chapter 3 of that Regulation.

2.   By way of derogation from paragraph 1, an institution’s internal methodology, or a part of it, for estimating default probabilities shall fulfil the requirements set out in paragraphs 3 or 4, as applicable, where, for a given issuer, all of the following conditions are met on a quarterly basis:

(a)	no external sources fulfilling the requirements set out in Article 2 are already available for estimating default probabilities for that issuer;

(b)

the use of an internal methodology, or a part of it, fulfilling the requirements set out in paragraph 1 is either: (i) not feasible due to a lack of input data for that issuer; or (ii) disproportionate in relation to the materiality or the holding period of the relevant positions for that issuer, based on the trading strategy adopted for such positions;

(c)

the value of ‘m’, calculated in accordance the formula laid down in paragraph 5, is any of the following: (i) lower than or equal to 10 %; (ii) higher than 10 %, and the institution carries out all of the following: (1) the institution investigates whether additional external sources fulfilling the requirements set out in Article 2 are available and uses those sources to reduce the value of ‘m’ to a value which is lower than or equal to 10 %; (2) the institution conducts a sensitivity and scenario analysis to assess the qualitative and quantitative soundness of the internal methodology or part of it.

For the sensitivity analysis referred to in point (c)(ii)(2), the institution shall assess the sensitivity of the own funds requirements calculated in accordance with Article 325bn(1) of Regulation (EU) No 575/2013 in relation to all trading book positions referred to in Article 325bl of that Regulation. The institution shall do so by assigning to the issuers covered at the time of the calculation by the internal methodology or part of it, which fulfils the requirements set out in paragraphs 3 or 4, as applicable, one rating grade higher than and one rating grade lower than the one used to fulfil the requirements set out in those paragraphs.

3.   Where the conditions set out in paragraph 2 are met, an institution’s internal methodology, or a part of it, shall assign to an issuer an estimate of default probability which is equal to or higher than the maximum of the following values:

(a)	the highest default probability assigned to investment grade issuers of positions under the scope of the institution’s internal default risk model and for which the conditions set out in paragraph 2 are not met;

(b)	the equally weighted average of default probabilities assigned to issuers of positions under the scope of the institution’s internal default risk model and for which the conditions set out in paragraph 2 are not met.

For the purposes of point (b), institutions may exclude defaulted issuers when calculating the equally weighted average of default probabilities, where they can ensure that the conditions set out in paragraph 2 are not met for such defaulted issuers.

4.   By way of derogation from paragraph 3, where the conditions set out in paragraph 2 are met and the own funds requirements for default risk decrease as the value of default probability assigned to a given issuer increases, an institution’s internal methodology or a part of it shall assign to that issuer an estimate of default probability which is equal to or lower than the value assigned in accordance with paragraph 3, point (b).

5.   For the purposes of paragraph 2, point (c), institutions shall calculate the value of ‘m’ in accordance with the following formula:

,

where:

DRC(full scope)	=	the own funds requirements calculated in accordance with Article 325bn(1) of Regulation (EU) No 575/2013 on the full scope of the trading book positions referred to in Article 325bl of that Regulation;
DRC(other methodologies and external sources)	=	the own funds requirements calculated in accordance with Article 325bn(1) of Regulation (EU) No 575/2013 relating exclusively to the trading book positions referred to in Article 325bl of that Regulation for the issuers of which the conditions set out in paragraph 2 are not met.