NBB Circular NBB_2019_31: EBA Guidelines on the application of the definition of default under Article 178 of Regulation (EU) No 575/2013

NBB_2019_31 – 5 December 2019 Circular – Page 1/3 14 Berlaimont Boulevard – BE-1000 Brussels tel. +32 2 221 30 17 company number: 0203.201.340 RPM Brussels www.bnb.be Circular Brussels, 5 December 2019 Reference: NBB_2019_31 your contact: Sietse Bracke tel. +32 2 221 21 65 Sietse.Bracke@nbb.be EBA Guidelines (EBA/GL/2016/07) on the application of the definition of default under Article 178 of Regulation (EU) No 575/2013 Scope Credit institutions, securities firms, resolution bodies and entities treated as resolution bodies under Belgian law, and branches established in Belgium of credit institutions and securities firms subject to the law of a non-EEA country, both on a consolidated and solo basis. Summary/Objective These guidelines clarify the requirements regarding the application of Article 178 of Regulation (EU) No 575/2013 (hereinafter the 'CRR') on the definition of default, in accordance with the mandate entrusted to the European Banking Authority (hereinafter 'the EBA') under Article 178(7) of that Regulation. These guidelines apply from 1 January 2021 to all exposures under the Standardised Approach for credit risk, and therefore institutions should integrate the requirements of these guidelines into their internal procedures and IT systems by that date. With regard to exposures under the Internal Ratings-Based (IRB) Approach for credit risk, a distinction is made between internal models that, under the finalised 'Basel III' package, continue to be modelled, and internal models that, under the finalised 'Basel III' package, disappear (namely LGD and CCF models for exposures to institutions and financial institutions treated as corporates). Regarding the first category of models, these guidelines apply from 1 January 2021; for the second category of models, they apply from 1 January 2024. By 1 January 2022 at the latest, internal models that continue to be modelled under the finalised 'Basel III' package must, where necessary, be modified following the new definition of default. For internal models that disappear under the finalised 'Basel III' package, modifications must be made by 1 January 2024 at the latest.

Circular – Page 2/3 NBB_2019_31 – 5 December 2019 Madam, Sir, By this circular, the National Bank of Belgium (NBB) intends to indicate that the EBA guidelines on the application of the definition of default under Article 178 of the CRR (EBA/GL/2016/07) have been integrated into its supervisory practice. This circular contains a brief summary of these guidelines, which can be consulted on the EBA website via the following link: https://eba.europa.eu/regulation-and-policy/credit-risk/guidelines-on-the-application-of-the-definition-of-default. Article 178 of the CRR sets out the conditions under which a debtor is deemed to be in default. The EBA guidelines clarify how to calculate the number of days past due under Article 178(1)(b) and what can be considered a technical past-due situation. Furthermore, they provide for specific treatment for exposures to central governments, local authorities, and public sector entities, as well as for exposures arising from factoring contracts and purchased receivables. The second part of these guidelines clarifies the modalities for application by institutions of the concept of probable absence of payment referred to in Article 178(1) and detailed in Article 178(3). In particular, the clarification concerns Article 178(3)(a) non-accrual of interest, (b) credit-specific risk adjustments, (c) sale of credit obligation, (d) emergency restructuring, and (e) and (f) bankruptcy. Other potential indicators of probable absence of payment are described. These guidelines also contain various provisions to ensure a harmonised definition of default:

• application of this definition to external data (only relevant for institutions using the IRB approach);
• criteria for return to non-default status;
• consistent application of the definition within institutions;
• application of the default definition for retail customers at the facility and debtor level;
• requirements regarding documentation, internal policies, and risk management processes. Finally, specific provisions apply to institutions using the IRB approach. To apply these guidelines for the first time, they should evaluate and adapt, where necessary, their rating systems so that risk parameter estimates reflect the new definition of default by applying the following: a) where possible, adapt historical data based on the new definition of default in accordance with these guidelines, notably taking into account the thresholds related to the significance of past due on a credit obligation referred to in Article 178(2)(d) of the CRR1; b) assess the significance of the impact of the new definition of default in accordance with these guidelines on all risk parameters and capital requirements, and in relation to the previous definition, where applicable, after relevant adaptations of historical data; c) include an additional prudential margin in their rating systems to account for potential distortions in risk estimates resulting from an inconsistent definition of default in the historical data used for modelling. These modifications to the rating systems resulting from the application of these guidelines must be verified by the internal validation function, and it will be necessary to examine whether these modifications do not 1 For less significant institutions, the objective is to align, in the coming months following the end of an ad hoc internal process within the ECB, with the application by the ECB to significant institutions as provided for in Regulation (EU) 2018/1845 of the ECB of 21 November 2018 on the exercise of the option under Article 178(2)(d) of the CRR concerning the threshold for assessing the significance of past due on credit obligations (ECB/2018/26).

NBB_2019_31 – 5 December 2019 Circular – Page 3/3 constitute a significant modification of the rating systems (within the meaning of Delegated Regulation (EU) No 529/2014), for which NBB approval is required. If institutions are required to obtain prior NBB authorisation to integrate these guidelines by the deadline referred to, they must agree with the NBB on the final deadline for submitting the application for approval of the modifications to the default definition. After having started collecting data according to the new definition of default, as set out in these guidelines, as part of their regular review of risk estimates provided for in Article 179(1)(c) of the CRR, institutions using the IRB approach should extend or, where applicable, defer the period of historical data used for risk quantification to include new data. Until an adequate period with a homogeneous definition of default is obtained, institutions using the IRB approach should, during their regular review of risk parameter estimates, assess the adequacy of the level of the prudential margin referred to in point c) above. These guidelines apply, from 1 January 2021, to all exposures under the Standardised Approach for credit risk, and therefore institutions should integrate the requirements of these guidelines into their internal procedures and IT systems by that date. With regard to exposures under the IRB Approach for credit risk, a distinction is made between internal models that, under the finalised 'Basel III' package, continue to be modelled, and internal models that, under the finalised 'Basel III' package, disappear (namely LGD and CCF models for exposures to institutions and financial institutions treated as corporates). Regarding the first category of models, these guidelines apply from 1 January 2021; for the second category of models, they apply from 1 January 2024. By 1 January 2022 at the latest, internal models that continue to be modelled under the finalised 'Basel III' package must, where necessary, be modified following the new definition of default. For internal models that disappear under the finalised 'Basel III' package, modifications must be made by 1 January 2024 at the latest. The French translation of these EBA guidelines is attached in full to this circular. This annex can be consulted on the NBB website. A copy of this circular is sent to the commissioner(s), approved auditor(s) of your institution. Please accept, Madam, Sir, the expression of my distinguished sentiments. Pierre Wunsch Governor Annex: only available via https://eba.europa.eu/regulation-and-policy/credit-risk/guidelines-on-the-application-of-the-definition-of-default : EBA Guidelines on the application of the definition of default under Article 178 of the CRR (EBA/GL/2016/07)