EBA Finalizes Guidelines on Estimation of LGD Under Economic Downturn
EBA published the final guidelines specifying how institutions should quantify the estimation of loss given default (LGD) appropriate for conditions of an economic downturn. The guidelines focus on requirements for the quantification of the calibration target used for downturn LGD estimation. The guidelines will apply as of January 01, 2021, but earlier implementation is encouraged. These guidelines are an amendment to the guidelines on PD, LGD estimation, and treatment of defaulted assets (EBA/GL/2017/16), which were published on November 20, 2017.
Starting from the relevant downturn period(s) identified in accordance with the related regulatory technical standard (RTS), the final guidelines set out requirements for the appropriate quantification of the calibration target used for downturn LGD estimates and include three types of approaches:
- Type-1 approaches can be applied when banks have sufficient loss data for the identified downturn period. In this case, institutions are allowed some modeling flexibility, but subject to a harmonized and prescriptive impact assessment.
- Type-2 approaches can be applied when banks do not have sufficient loss data for the identified downturn period. In this case, institutions are given the choice between two approaches, the so-called haircut, or extrapolation approaches This will harmonize the approaches used by banks.
- Type-3 approaches can be applied in rare cases, where neither type-1 nor type-2 approaches can be used. In this case, banks have to apply a minimum margin of conservatism requirement of 15 percentage points on LGD estimates.
Finally, a reference value is put in place that acts as a non-binding challenger to the final downturn LGD estimation. The guidelines complete the broader work of EBA on the review of the internal ratings-based (IRB) approach and aim to reduce the unjustified variability in the outcomes of internal models, while preserving the risk-sensitivity of capital requirements.
Related Links
Effective Date: January 01, 2021
Keywords: Europe, EU, Banking, Credit Risk, IRB Approach, LGD, Economic Downturn, EBA
Previous Article
BoE, FCA, and MAS Announce Collaboration on Cyber SecurityRelated Articles
BIS and Central Banks Experiment with GenAI to Assess Climate Risks
A recent report from the Bank for International Settlements (BIS) Innovation Hub details Project Gaia, a collaboration between the BIS Innovation Hub Eurosystem Center and certain central banks in Europe
Nearly 25% G-SIBs Commit to Adopting TNFD Nature-Related Disclosures
Nature-related risks are increasing in severity and frequency, affecting businesses, capital providers, financial systems, and economies.
Singapore to Mandate Climate Disclosures from FY2025
Singapore recently took a significant step toward turning climate ambition into action, with the introduction of mandatory climate-related disclosures for listed and large non-listed companies
SEC Finalizes Climate-Related Disclosures Rule
The U.S. Securities and Exchange Commission (SEC) has finalized the long-awaited rule that mandates climate-related disclosures for domestic and foreign publicly listed companies in the U.S.
EBA Proposes Standards Related to Standardized Credit Risk Approach
The European Banking Authority (EBA) has been taking significant steps toward implementing the Basel III framework and strengthening the regulatory framework for credit institutions in the EU
US Regulators Release Stress Test Scenarios for Banks
The U.S. regulators recently released baseline and severely adverse scenarios, along with other details, for stress testing the banks in 2024. The relevant U.S. banking regulators are the Federal Reserve Bank (FED), the Federal Deposit Insurance Corporation (FDIC), and the Office of the Comptroller of the Currency (OCC).
Asian Governments Aim for Interoperability in AI Governance Frameworks
The regulatory landscape for artificial intelligence (AI), including the generative kind, is evolving rapidly, with governments and regulators aiming to address the challenges and opportunities presented by this transformative technology.
EBA Proposes Operational Risk Standards Under Final Basel III Package
The European Union (EU) has been working on the final elements of Basel III standards, with endorsement of the Banking Package and the publication of the European Banking Authority (EBA) roadmap on Basel III implementation in December 2023.
EFRAG Proposes XBRL Taxonomy and Standard for Listed SMEs Under ESRS
The European Financial Reporting Advisory Group (EFRAG), which plays a crucial role in shaping corporate reporting standards in European Union (EU), is seeking comments, until May 21, 2024, on the Exposure Draft ESRS for listed SMEs.
ECB to Expand Climate Change Work in 2024-2025
Banking regulators worldwide are increasingly focusing on addressing, monitoring, and supervising the institutions' exposure to climate and environmental risks.
