(1)

Article 325bp(5), point (e), and Article 325bp(6), point (d), of Regulation (EU) No 575/2013 require institutions that have not been granted permission to estimate default probabilities or losses given default in accordance with Part Three, Title II, Chapter 3, Section 1 of that Regulation for the purposes of calculating their own funds requirement for credit risk, to develop an internal methodology or to use external sources to estimate those default probabilities and losses given default for the purposes of calculating their own funds requirement for market risk referred to in Article 325bl of that Regulation. In order to ensure a level playing field across institutions in the Union, the requirements for such an internal methodology should be the same as those that apply to the methodologies used by institutions that have been permitted to estimate default probabilities or losses given default in accordance with Part Three, Title II, Chapter 3, of that Regulation. However, cases can be envisaged where, for the purposes of calculating their own funds requirement for market risk, institutions can neither rely on external sources of data, nor reasonably run their models in accordance with the requirements set out in Part Three, Title II, Chapter 3, of that Regulation, due to the lack of input data or disproportionate effort required. Therefore, it is necessary to lay down specific requirements that enable the institutions’ internal methodology used for the purposes of calculating the own funds requirement for market risk, or parts of it, to cover all such cases adequately. Those specific requirements should ensure prudent outcomes. At the same time, those requirements should meet specific needs in terms of timeliness and flexibility, including situations where positions for certain issuers are too small to require a complex methodology, and hence, a simpler methodology is more appropriate.

(2)

Those specific requirements should only apply where necessary, that is, only where institutions can neither rely on external sources of data, nor reasonably run models satisfying the requirements set out in Part Three, Title II, Chapter 3, of Regulation (EU) No 575/2013. Therefore, conditions should be laid down to ensure that there are no other sources for estimating default probabilities and losses given default, and that the cases in which institutions can neither rely on external sources, nor reasonably run their models do not represent an excessive amount of their portfolios considering the requirements laid down in Article 325bn(1) of that Regulation. Institutions should assess those conditions frequently enough to take into account potential changes, including changes to the availability of external data sources, and considering the frequency with which the own funds requirements for market risk are reported.

(3)

To enable institutions to take into account the characteristics of the positions for different issuers, including the materiality and holding periods of those positions, institutions should be allowed to develop internal methodologies for the estimation of default probabilities and losses given default which consist of different parts, to cover those different positions.

(4)

It is necessary to ensure that the risk of default of individual issuers is sufficiently capitalised. The estimates of default probabilities and losses given default based on an internal methodology, or a part of it, should therefore be sufficiently conservative, having regard to other methodologies and sources used by the institutions. To that end, it is necessary to specify the conditions under which the estimates of default probabilities and losses given default will be sufficiently conservative. In particular, for those cases in which institutions can neither rely on external sources of data, nor reasonably run their models, limits should be set to the values that the estimates of default probabilities and losses given default may assume.

(5)

Institutions that use external sources to estimate default probabilities and losses given default should, as part of the validation of the internal default risk model, periodically review the estimates produced to ensure that those estimates remain appropriate for the institutions’ portfolios. Institutions that use more than one external source should establish a hierarchy of those external sources to ensure the overall consistency of their use in the internal default risk model. Furthermore, institutions that use external sources to estimate default probabilities may have to undertake a number of steps and procedures before they can produce the actual estimates of default probabilities. It is therefore necessary to lay down requirements to ensure that the methodology used to produce estimates of default probabilities from external sources is conceptually sound in that it produces accurate and consistent estimates that are not biased.

(6)

Article 325bp(11) of Regulation (EU) No 575/2013 requires institutions to document their internal models so that their correlation assumptions and other modelling assumptions are transparent to the competent authorities. To assist competent authorities in ensuring compliance with that requirement, it is necessary to specify how that general documentation requirement is to be applied to internal methodologies or external sources used under the internal default risk model for estimating default probabilities and losses given default.

(7)

This Regulation is based on the draft regulatory technical standards submitted to the Commission by the European Banking Authority.

(8)

The European Banking Authority has conducted open public consultations on the draft regulatory technical standards on which this Regulation is based, analysed the potential related costs and benefits and requested the advice of the Banking Stakeholder Group established in accordance with Article 37 of Regulation (EU) No 1093/2010 of the European Parliament and of the Council (2),