PRA is proposing, via CP7/21, the approach to implementing new requirements related to the specification of the nature, severity, and duration of an economic downturn in the internal ratings-based (IRB) approach to credit risk. The proposals would result in the addition of a new Economic Downturn–Credit Risk Part of the PRA Rulebook (Appendix 1) and the amended expectations in the supervisory statement SS11/13 on IRB approaches (Appendix 2). The amended SS11/13 would be in line with the version of the Capital Requirements Regulation (CRR) that was on-shored at the end of the transition period. The comment period for this consultation ends on July 07, 2021 and PRA proposes the implementation date for the changes resulting from CP7/21 to be January 01, 2022.
The proposals in CP7/21 are relevant for UK banks, building societies, and PRA-designated UK investment firms. The PRA rationale for proposing requirements that specify the nature of an economic downturn is to ensure that consistent and relevant economic indicators are considered. The rationale for proposing to introduce requirements that specify the severity and duration of an economic downturn is to ensure that downturn estimates of loss given default and exposure at default reflect consistent and sufficiently severe downturn scenarios and that the selected downturn period is of sufficient duration to adequately capture the economic impact of a particular downturn event.
Within the proposed technical standards in the PRA Rulebook (Appendix 1), PRA proposes a consistent set of economic indicators that would be considered relevant for all exposures, as PRA considers them to be the key indicators of an economic cycle. For specifying the severity of the economic downturn and for identifying the most severe values associated with each relevant economic indicator, PRA proposes to require firms to use a historic time period that is sufficiently long to provide values that are representative of the values that may be taken by those economic indicators in the future, including in a future severe downturn. Additionally, PRA proposes to require firms to consider a period of at least 20 years to promote consistency of the downturn estimates of firms.
For the duration of an economic downturn, PRA proposes that a single downturn period should be long enough to cover all the peaks or troughs related to the most severe twelve-month values observed for the different economic indicators associated with that single downturn period. To capture cases where indicators’ twelve-month values peak or trough at the same time or shortly after one another, PRA proposes to introduce a requirement that firms shall combine economic downturns into a single downturn period. The proposed implementation date for the changes resulting from CP7/21 is January 01, 2022; this date is in line with the implementation deadlines set out in the policy statement PS11/20 on the probability of default and loss given default estimation, to enable IRB firms to implement all changes from the IRB roadmap. Firms should continue to submit model change applications in line with the submission timings communicated by their supervisors. In addition to other aspects, PRA invites feedback from firms on the expected impact of the proposals on capital requirements.
Comment Due Date: July 07, 2021
Effective Date: January 01, 2022
Keywords: Europe, UK, Banking, Credit Risk, IRB Approach, Economic Downturn, PRA Rulebook, LGD, EAD, Basel, PRA
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