November 20, 2017

EBA published the final guidelines on the estimation of risk parameters for non-defaulted exposures and on the treatment of defaulted exposures under the advanced internal ratings-based (IRB) approach. The non-defaulted exposures include the estimation of risk parameters such as the probability of default (PD) and the loss given default (LGD) while the defaulted exposures include estimation of parameters such as best estimate of expected loss (ELBE) and LGD in-default. The guidelines are complemented by a report on the results of EBA qualitative survey conducted across the EU banks using the IRB approach. The guidelines apply from January 01, 2021, but competent authorities may accelerate the timeline of this transition at their discretion.

The guidelines clarify the estimation of risk parameters under the IRB Approach, with focus on PD and LGD parameters, on selected aspects of the application of these risk parameters, and on the regular reviews of estimates. The clarifications focus on the main concepts and definitions underlying the calibration of risk parameters, as these are the basis for the calculation of capital requirements and, therefore, have to be identified in an objective manner. The clarifications included in the guidelines cover, among other items, the discounting factor used to calculate realized LGD on historical observations. EBA is also planning to publish a list of equivalent interest rates for exposures in currencies other than euro to be used in the LGD estimation.

The report on IRB modeling practices includes an overview of the current practices in IRB modeling and provides a detailed impact assessment of the guidelines. Changes are expected to apply to the majority of existing models to ensure compliance with these guidelines. However, the materiality of these changes will have to be assessed and treated in accordance with the Commission Delegated Regulation (EU) No 529/2014 on the materiality of extensions and changes to rating systems. These guidelines, which are part of EBA's regulatory review of the IRB approach, aim to restore market participants' trust in internal models by reducing the unjustified variability in their outcomes, ensuring comparability of risk estimates and preserving risk-sensitivity of capital requirements.

 

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Effective Date: January 01, 2021

Keywords: Europe, EU, Banking, IRB Approach, PD and LGD, Advanced Approaches, EBA

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