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    EBA to Amend Regulatory Technical Standards on Credit Risk Adjustments

    December 13, 2021

    The European Banking Authority (EBA) published the final report amending the draft regulatory technical standards on credit risk adjustments used in the calculation of the risk-weight of defaulted exposures under the standardized approach to credit risk. The draft standards amend the Delegated Regulation 183/2014 on prudential requirements for credit institutions and investment firms. The proposed amendments follow up on the Action Plan of the European Commission to tackle Non-Performing Loans (NPLs) in the aftermath of the COVID-19 pandemic; the plan indicated the need for a revision of the treatment of purchased defaulted exposures under the standardized approach.

    The Action Plan of the European Commission specifically asks EBA to reconsider the appropriate regulatory treatment of the risk-weight for purchased defaulted assets, as laid out in the Capital Requirements Regulation (CRR), which have been sold at a discount (NPL sales). Under the current regulatory framework, the capital charge for a defaulted exposure may—under certain circumstances—increase after its sale from a risk-weight of 100% on the seller’s balance sheet to a risk-weight of 150% on the balance sheet of the credit institution buying the assets. The proposed amendment to the existing regulatory technical standards on credit risk adjustments introduces a change to the recognition of total credit risk adjustments to ensure that the risk-weight remains the same in both cases. In particular, the price discount stemming from the sale will be recognized as a credit risk adjustment for the purposes of determining the risk-weight. By implementing this change through an amendment to the regulatory standards, EBA aims to clarify the regulatory treatment of sold NPL assets. EBA also recommends that the treatment set out in this set of regulatory technical standards be directly reflected in the level 1 text, in line with European Commission CRR3 proposal.

    Article 110(4)(e) of CRR (Regulation 575/2013) mandates EBA to specify the amounts that need to be included in the calculation of credit risk adjustments for the determination of default under Article 178 of CRR. In light of the COVID-19 pandemic, it is desirable to remove any impediment to the creation of secondary markets for defaulted exposures. In this context, a misalignment between the risk-weight applied to defaulted assets and the potential for unexpected losses in relation to the level of already expected losses could create undue obstacles for credit institutions to move their non-performing loans off their balance sheets. Therefore, it is necessary to ensure that the specific credit risk adjustments recognized for Article 127(1) of CRR incorporate any discount in a transaction price that the buyer has not recognized by increasing the common equity tier 1 capital. This revision is necessary to ensure that the prudential framework does not create disincentives to the sale of non-performing assets by banks. The final draft regulatory technical standards will be submitted to the European Commission for endorsement before being published in the Official Journal of the European Union and will apply 20 days after their publication in this Official Journal.

     

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    Keywords: Europe, EU, Banking, Basel, CRR, Regulatory Technical Standards, Credit Risk, Regulatory Capital, Risk-Weighted Assets, Defaulted Exposures, Standardized Approach, EBA

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