NBB Circular NBB_2020_047: EBA Guidelines on PD, LGD, and Defaulted Exposures (EBA/GL/2017/16) and Downturn LGD (EBA/GL/2019/03)

NBB_2020_047 – 8 December 2020 Circular – Page 1/4 boulevard de Berlaimont 14 – BE-1000 Brussels tel. +32 2 221 30 17 company number: 0203.201.340 RPM Brussels www.bnb.be

Circular
Brussels, 8 December 2020
Reference: NBB_2020_047
Your correspondent:
Claire Renoirte tel. +32 2 221 53 50 claire.renoirte@nbb.be

EBA Guidelines on probability of default (PD) estimates, loss given default (LGD) estimates, and on the treatment of exposures on which there has been a default (EBA/GL/2017/16), and on appropriate loss given default (LGD) estimates in the event of an economic downturn (EBA/GL/2019/03)

Scope
This circular applies to credit institutions, stock exchange companies, resolution bodies and bodies assimilated to resolution bodies under Belgian law, as well as to branches established in Belgium of credit institutions and stock exchange companies subject to the law of a country not a member of the EEA (hereinafter 'the institutions'), both on a consolidated basis and on a solo basis, when they calculate their capital requirements on the basis of an 'internal ratings-based' approach (IRB approach, hereinafter 'IRB approach').

Summary/Objective
The EBA guidelines EBA/GL/2017/16 (hereinafter 'the EBA guidelines on PD and LGD') specify the requirements concerning probability of default (hereinafter 'PD') and loss given default (hereinafter 'LGD') estimates, including the LGD for exposures on which there has been a default and the best estimate of expected loss (hereinafter 'ELBE'), in accordance with Part Three, Title II, Chapter 3, Section 6, of Regulation (EU) No 575/2013 (hereinafter 'CRR'), Article 159 of that Regulation and the draft regulatory technical standards of the EBA on the assessment method for the internal ratings-based approach (IRB, hereinafter 'IRB assessment RTS') (EBA/RTS/2016/03 (hereinafter 'IRB assessment RTS') of 21 July 2016).

Circular – Page 2/4 NBB_2020_047 – 8 December 2020 These guidelines apply in relation to the IRB approach, in accordance with Part Three, Title II, Chapter 3, of the CRR, to all methods based on own estimates of PD and LGD. When, for exposures other than retail exposures, an institution has obtained authorization to use the IRB approach but has not obtained authorization to use its own LGD estimates in accordance with Article 143, paragraph 2, read in conjunction with Article 151, paragraphs 8 and 9, of the CRR, all parts of these guidelines apply, except for Chapters 6 and 7. These guidelines do not apply to the calculation of capital requirements for dilution risk in accordance with Article 157 of the CRR. These guidelines specify in particular the requirements for (1) model development, (2) calibration of risk parameters (PD and LGD, as well as ELBE and LGD for defaulted exposures), applying, if necessary, adequate prudent margins, (3) application of these risk parameters, for example for the calculation of the shortfall or excess of IRB (cf. shortfall or excess of provisions), and (4) revision of estimates. The EBA guidelines EBA/GL/2019/03 (hereinafter 'EBA guidelines on LGD downturn') should be considered as an amendment to the EBA guidelines on PD and LGD mentioned above. These guidelines specify the requirements concerning appropriate loss given default estimates in the event of an economic downturn (hereinafter 'LGD downturn') in accordance with Part Three, Title II, Chapter 3, Section 6, of the CRR, Article 181 of the CRR and the draft regulatory technical standards of the EBA on the IRB assessment method (EBA/RTS/2016/03 [IRB assessment RTS] of 21 July 2016), as well as the draft regulatory standards of the EBA on the specifications of an economic downturn (EBA/RTS/2018/04 [RTS on economic downturn] of 16 November 2018). The EBA guidelines on LGD downturn apply in relation to the IRB approach to all methods based on own LGD estimates. The use of own LGD downturn estimates, in accordance with these guidelines, is subject to the approval of the supervisory authority in accordance with Article 144 of the CRR. These guidelines do not apply to the calculation of capital requirements for dilution risk in accordance with Article 157 of the CRR. These guidelines specify that institutions must first identify the relevant periods of economic downturn for the type of exposure considered, in accordance with the draft regulatory technical standards of the EBA on the specifications of an economic downturn (EBA/RTS/2018/04 [RTS on economic downturn] of 16 November 2018) 1. They then specify the general requirements for LGD downturn estimation, also in the event of default, as well as the estimation requirements depending on whether the impact can be observed, estimated, or is unavailable. Useful examples clarifying the requirements for appropriate loss given default (LGD) estimates in the event of an economic downturn are available in the English
version of these guidelines (EBA/GL/2019/03). This can be consulted on the EBA website. Both guidelines (EBA/GL/2017/16 and EBA/GL/2019/03) apply from 1 January 2021. 1 The guidelines will be adapted, where appropriate, when the RTS on economic downturn are published in their final version in the Official Journal.

NBB_2020_047 – 8 December 2020 Circular – Page 3/4 Following the requirements of these two guidelines, institutions should make modifications to their internal ratings systems by 1 January 2022.
The institution's internal validation function should verify the modifications made to the internal ratings systems following the application of these guidelines, in accordance with the draft regulatory technical standards of the EBA on the IRB assessment method (EBA/RTS/2016/03 [IRB assessment RTS] of 21 July 2016), as well as the classification of modifications, in accordance with Commission Delegated Regulation (EU) No 529/2014 of 12 March 2014 2. Institutions required to obtain prior authorization from the competent authorities, in accordance with Article 143, paragraph 3, of the CRR and Delegated Regulation (EU) No 529/2014, for the modifications to the IRB systems required to integrate these guidelines for the first time by 1 January 2022, should agree with their competent authorities on the ultimate deadline for submitting the application for this prior authorization. For IRB models that disappear under the final Basel III agreement (i.e., own LGD (and conversion factor) estimation models for exposures on (1) institutions and (2) enterprises with consolidated revenues exceeding 500,000 euros), these guidelines will enter into force on 1 January 2024. The modifications to these models required to integrate the guidelines of this circular must be carried out, where applicable, by that date at the latest.

Madam,
Sir,
The National Bank of Belgium wishes to indicate by this circular that the EBA guidelines on probability of default (PD) estimates, loss given default (LGD) estimates, and on the treatment of exposures on which there has been a default (EBA/GL/2017/16), as well as the EBA guidelines on loss given default (LGD) estimates appropriate in the event of an economic downturn (EBA/GL/2019/03), are integrated into its supervisory practice. This circular specifies in particular the requirements for (1) model development, (2) calibration of risk parameters (PD and LGD as well as BEEL and LGD for defaulted exposures), applying, if necessary, adequate prudent margins, (3) application of these risk parameters, for example for the calculation of the shortfall or excess of IRB (cf. shortfall or excess of provisions), and 2 OJ L 148 of 20.05.2014, p. 36.

Circular – Page 4/4 NBB_2020_047 – 8 December 2020 (4) revision of estimates. It also specifies the general requirements for LGD downturn estimation, also in the event of default, as well as the estimation requirements depending on whether the impact can be observed, estimated, or is unavailable.
This circular requires that institutions modify, if necessary, their risk parameter estimates to comply with the requirements of these two EBA guidelines, by 1 January 2022.
However, if modifications are necessary for IRB models that disappear under the final Basel III agreement (i.e., own LGD (and conversion factor) estimates for exposures to institutions and enterprises (with consolidated revenues exceeding 500,000 euros)), these may be integrated by 1 January 2024 at the latest.
This circular contains a short summary of these guidelines, which can be consulted on the EBA website by clicking on the following links:
https://eba.europa.eu/sites/default/documents/files/documents/10180/2192133/f0b14b3f-d82a-4575-93db-cf6e8e4b6156/Guidelines%20on%20PD%20and%20LGD%20estimation%20(EBA-GL-2017-16)_FR.pdf; https://eba.europa.eu/sites/default/documents/files/documents/10180/2759150/26c5e126-7362-4d96-81011ac0cb5f75d3/Guidelines%20on%20LGD%20estimates%20under%20downturn%20conditions_FR.pdf. Useful examples clarifying the requirements for appropriate loss given default (LGD) estimates in the event of an economic downturn are available in the English version of these guidelines (EBA/GL/2019/03). This can be consulted on the EBA website by clicking on the following link:
https://eba.europa.eu/sites/default/documents/files/documents/10180/2551996/f892da33-5cb2-44f8-ae5d68251b9bab8f/Final%20Report%20on%20Guidelines%20on%20LGD%20estimates%20under%20downturn%20conditions.pdf.
A copy of this circular is sent to the auditor(s), approved auditor(s) of your institution.
I have the honour to be, Madam, Sir, your obedient servant.

Pierre Wunsch
Governor

Appendices:
(1) Guidelines on probability of default (PD) estimates, loss given default (LGD) estimates, and on the treatment of exposures on which there has been a default (EBA/GL/2017/16) of 23 April 2018 (2) Guidelines on loss given default (LGD) estimates appropriate in the event of an economic downturn ('LGD estimates under economic downturn') (EBA/GL/2019/03) of 6 March 2019