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    EBA Consults on Guide for Estimating Economic Downturn in IRB Modeling

    May 22, 2018

    EBA published two consultation papers: one on the draft regulatory technical standards specifying an economic downturn and the other on a set of guidelines for the estimation of loss given default (LGD) appropriate for conditions of an economic downturn. The regulatory technical standards specify the nature, severity, and duration of an economic downturn. The consultations run until June 22, 2018. The regulatory technical standards shall enter into force on December 31, 2019.

    The draft regulatory technical standards now focus solely on the identification approach, as a result of the feedback received on the first consultation (published in March 2017). The draft regulatory standards require institutions to consider relevant macroeconomic and credit factors when specifying the nature of an economic downturn. The severity and duration of an economic downturn should be specified, taking into account the time series for the identified relevant macroeconomic and credit factors. The draft standards ensure that an economic downturn for comparable portfolios are subject to the same economic downturn. The draft standards have been developed in accordance with Articles 181 (3)(a) and 182 (4)(a) of the Capital Requirements Regulation (CRR), which mandate EBA to draft regulatory technical standards to specify the nature, severity, and duration of an economic downturn referred to in paragraphs 181 (1)(b) and 182(1)(b).
     
    The draft guidelines supplement the regulatory technical standards and clarify how institutions should quantify LGD estimates appropriate for an economic downturn identified according to the draft regulatory technical standards. The draft guidelines focus on the methods institutions should use to quantify downturn LGD estimates. Several approaches are allowed and will be driven by the availability of loss data for the estimations. In situations with limited data availability, more prescriptive approaches are applied. The guidelines addresses downturn LGD estimation, taking into account the specificities of the institutions' processes, underwriting standards, and general response to adverse economic conditions. The guidelines will be included into the guidelines on Probability of Default, LGD estimation, and defaulted assets and aligned in structure with the subject matter, scope of application, addressees, definitions, and application date.
     
    This package is part of the broader work of EBA on the review of the internal ratings-based (IRB) approach, which aims to reduce the unjustified variability in the outcomes of internal models while preserving the risk-sensitivity of capital requirements. 

     

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    Comment Due Date: June 22, 2018

    Effective Date: December 31, 2019 (Standards)

    Keywords: Europe, EU, Banking, IRB Approach, Regulatory Technical Standards, LGD Estimation, Guideline, EBA

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