NBB Circular NBB_2021_33: Implementation of EBA Guidelines on Credit Risk Mitigation for IRB Institutions with Own-Estimated LGD

NBB_2021_33 – 23 December 2021 Circular – Page 1/3 boulevard de Berlaimont 14 – BE-1000 Brussels tel. +32 2 221 38 12 company number: 0203.201.340 RPM Brussels www.bnb.be

Circular
Brussels, 23 December 2021
Reference: NBB_2021_33 your contact:
Claire Renoirte tel. +32 2 221 53 50 claire.renoirte@nbb.be

EBA Guidelines of 6 May 2020 on credit risk mitigation for institutions applying the IRB approach with their own Loss Given Default (LGD) estimates (EBA/GL/2020/05)

Scope
This circular applies to credit institutions, securities companies, resolution bodies and entities equivalent to resolution bodies, under Belgian law, as well as to branches established in Belgium of credit institutions and securities companies subject to the law of a non-EEA country (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 (hereinafter “IRB approach” or “IRB”) with their own Loss Given Default (LGD) estimates (hereinafter “LGD”).

Summary/Objectives
This circular implements the EBA Guidelines of 6 May 2020 on credit risk mitigation for institutions applying the IRB approach with their own Loss Given Default (LGD) estimates (EBA/GL/2020/05).

It complements Circular NBB_2020_047 of 8 December 2020 implementing the EBA Guidelines on Probability of Default (PD) estimates, Loss Given Default (LGD) estimates and on the treatment of exposures where a default has occurred (EBA/GL/2017/16), and on appropriate Loss Given Default (LGD) estimates in the event of an economic slowdown (EBA/GL/2019/03).

It thus concludes the set of circulars implementing the EBA guidelines aimed at harmonising the practices of European institutions regarding the definition of default and the calculation of regulatory capital requirements when they apply an internal model approach 1.

These guidelines specify the requirements concerning the use of credit risk mitigation in accordance with the relevant provisions of Part Three, Title II, Chapter 3, of Regulation (EU) No 575/2013 (hereinafter “CRR”), as defined in Article 108, paragraph 2, of that Regulation 2, in particular for institutions authorised to use their own LGD estimates in accordance with Article 143 of that Regulation.

1 It also complements the EBA report on credit risk mitigation of 19 March 2018 (EBA BS 2018 xxx (EBA Report on CRM framework).docx (europa.eu)) which was limited to its application in the Standardised Approach and in the IRB approach when institutions cannot use their own LGD estimates (IRB foundation).

Circular – Page 2/3 NBB_2021_33 – 23 December 2021

They stem from the delegated regulation of 20 October 2021 supplementing Regulation (EU) No 575/2013 concerning technical standards for the determination of the assessment method for internal models (RTS on the IRB assessment method (EBA/RTS/2016/03)). https://ecropa.eu/finance/docs/level-2-measures/crr-rts-2021-7470_en.pdf

They aim to eliminate unjustified differences in the practices of supervisors and the choices of institutions when taking into account credit risk mitigation techniques for the calculation of capital requirements. They thus clarify in particular the eligibility conditions and the recognition of financed 3 and unfinanced 4 credit protections, in accordance, on the one hand, with Articles 166 and 181, and on the other hand, with Article 160, paragraph 5, Article 161, paragraph 3, Article 163, paragraph 4, Article 164, paragraph 2, and Article 183 of the CRR.

Section 4 of these guidelines clarifies which relevant articles of the CRR should be considered to determine the recognised credit protections based on their characteristics, in particular for credit insurance. If the latter meets the definition of an unfinanced credit protection within the meaning of Article 4, paragraph 1, point 59, of the CRR, it may be taken into account as credit risk mitigation with regard to its functioning, i.e., either as a guarantee or as a credit derivative.

Section 5 of these guidelines specifies the eligibility criteria for financed and unfinanced credit protections. It recalls the CRR requirements regarding legal certainty for each type of credit protection. It also clarifies the terms that legal opinions must comply with to ensure the legally valid and enforceable nature of the various credit protections and thus their eligibility for regulatory purposes. For financed credit protections, this section finally specifies that institutions using an IRB approach with their own LGD estimates must comply with the collateral revaluation conditions specified in the CRR by type of collateral for the Standardised Approach.

Section 6 of these guidelines clarifies the requirements for calculating the effect of financed and unfinanced credit protections on capital requirements.

For the recognition of financed credit protections, it recalls in particular that LGD estimates must prudently take into account collateral whose location could jeopardise the institution’s ability to take control of it quickly or for which the institution does not have a first-ranking right.

For unfinanced credit protections, this section recalls the different authorised methods for calculating their effect on capital requirements, including the adjustment or substitution of risk parameters, or the substitution of risk weights when the institution applies the Standardised Approach for comparable direct exposures on the guarantor. It clarifies that institutions should define internal policies that are consistent with their internal risk management practices and that comply with the CRR and these guidelines. These internal policies should clearly indicate which method for calculating the effect of unfinanced credit protections is used for each rating system. Institutions should apply these policies consistently over time.

Importantly, this section clarifies that when unfinanced credit protections do not meet the eligibility conditions specified in these guidelines, as well as those specified in the CRR regarding guarantors and collateral, they are therefore not considered eligible. Consequently, cash flows received upon their exercise should be treated as if they had been received without using the unfinanced credit protection. The source and amounts of these cash flows should furthermore be tracked regularly to ensure their appropriate allocation for the calculation of capital requirements, where applicable through appropriate adjustments to avoid any bias in Probability of Default (PD) and LGD estimates.

This Section 6 finally clarifies how to ensure adequate prudence when taking into account unfinanced credit protections in the calculation of capital requirements, for the different methods authorised for calculating their effect. It clarifies in particular how to calculate this effect when unfinanced credit protections cover only part of an exposure or when an exposure is covered by different types of credit protection. It also clarifies how to calculate the effect of these protections when the institution uses different regulatory approaches for calculating the respective credit risk of clients and guarantors, namely the Standardised Approach or one of the modelled approaches.

Section 6 finally clarifies how to calculate the risk weight floor to ensure that the final risk weight used for the calculation of capital requirements, after taking into account unfinanced credit protections, is not lower than that of a comparable direct exposure on the guarantor, in accordance with Article 161, paragraph 3, and Article 164, paragraph 2, of the CRR.

Madam,
Sir,

The National Bank of Belgium wishes to indicate by this circular that the EBA Guidelines of 6 May 2020 on credit risk mitigation for institutions applying the IRB (Internal Ratings-Based) approach with their own Loss Given Default (LGD) estimates (EBA/GL/2020/05) are integrated into its supervisory practice, from 1 January 2022.

These guidelines clarify the applicable rules to adequately and prudently take credit protections into account in the calculation of capital requirements.

The circular contains a short summary of these guidelines. The annex reproducing the EBA guidelines can be consulted on the website of the National Bank of Belgium.

A copy of this circular is sent to the commissioner(s), approved auditor(s) of your institution.

Please accept, Madam, Sir, the assurance of my distinguished consideration.

Pierre Wunsch
Governor

Annex: EBA Guidelines of 6 May 2020 on credit risk mitigation for institutions applying the IRB approach with their own Loss Given Default (LGD) estimates (EBA/GL/2020/05).