PRA Proposal on Probability of Default and LGD Estimation

EBA has developed a roadmap of regulatory products with the aim of reducing unwarranted variability in the risk-weighted assets (RWAs) calculated using IRB models of banks. The following three products from the EBA roadmap relate to PD and LGD estimation—

• Guidelines on PD estimation, LGD estimation, and the treatment of defaulted exposures
• Final draft regulatory technical standards on the specification of the nature, severity, and duration of an economic downturn, in accordance with Articles 181(3)(a) and 182(4)(a) of Capital Requirements Regulation (EU No 575/2013)
• Guidelines for the estimation of LGD appropriate for an economic downturn

CP21/19 sets out the proposed approach of PRA to implementing these three products. The proposals are related to compliance with the EBA roadmap for IRB, cyclicality of downturn LGD estimates, discount rate, use of a component-based modeling approach for downturn LGD, identification of an economic downturn, LGD exposure level floor for residential mortgages, and treatment of defaulted exposures. PRA notes that the regulatory technical standards on economic downturn are, at the time of publication, in draft. CP21/19 (including the proposed changes to SS11/13) assumes that the regulatory technical standards will be made in the same form as the draft. PRA will consider further changes that may be required to SS11/13 if the final regulatory technical standards differ from the current draft. The policy proposals set out in CP21/19 have been designed in the context of the current UK and EU regulatory framework. In the event that UK leaves EU with no implementation period in place, PRA has assessed that the proposals would not need to be amended under the EU (Withdrawal) Act 2019.

Earlier, PRA had decided to consult on its implementation of the EBA roadmap in two phases. In the first phase, PRA had consulted on its approach to implementing these products in CP17/18 in July 2018 and published the final approach on the definition of default in the policy statement PS7/19 in March 2019. PRA is now proposing to update the implementation deadlines published in the policy statement PS7/19 on definition of default. The following are the proposed updated deadlines:

• December 31, 2020—Deadline for IRB firms to implement all changes from the EBA roadmap for residential mortgage portfolios, including all of the definition of default changes. Also, deadline for firms that use the standardized approach for calculating capital requirements for credit risk to apply all changes to the definition of default, with the exception of changes from the guidelines on the application of the definition of default for non-mortgage portfolios.
• January 01, 2022—Deadline for IRB firms to implement all changes from the EBA roadmap for all other exposure classes. For the avoidance of doubt, this includes the changes to the definition of default for the identification of defaults (except for residential mortgage portfolios, where all changes are subject to the December 31, 2020 deadline). Also, deadline for firms that use the SA for calculating capital requirements for credit risk to apply changes from the guidelines on the application of the definition of default for non-mortgage portfolios.

Related Links

• Notification
• CP21/19 (PDF)
• PS7/19 and CP17/18

Comment Due Date: December 18, 2019

Effective Date: December 31, 2020/January 01, 2022 (Proposed)

Keywords: Europe, EU, UK, Banking, Credit Risk, Definition of Default, CRR, IRB Approach, LGD Estimation, PS 7/19, CP 21/19, SS 11/13, PD Estimation, Basel III, EBA, PRA