The Capital Requirements Regulation (CRR) establishes the definition of default of an obligor that is used for the purpose of the IRB Approach and for the Standardised Approach for credit risk. However, in the absence of specific rules in this regard, the EBA has identified differing practices used by institutions when applying the definition of default.
In this context, the EBA published in September 2016 the following documents:
- Guidelines (GL) specifying the application of the definition of default, which clarify aspects regarding the past due criterion, the indications of unlikeliness to pay (UTP), the criteria for the return to a non-defaulted status, etc.
- RTS on the materiality threshold of past due credit obligations, which specify the conditions that competent authorities (CAs) shall apply when setting the materiality threshold for credit obligations.
Both the Guidelines and the RTS will harmonise the definition of default across the EU.
Along with these documents, the EBA published the results of a Quantitative Impact Study (QIS) aimed at assessing the impact on the regulatory capital requirements of selected policy options to harmonise the definition of default.
This document prepared by the R&D area of Management Solutions analyses the requirements arising from the Guidelines and the RTS, and also an assessment of the implications for institutions.
On the one hand, the guidelines clarify aspects related to the past due criterion, the indications of unlikeliness to pay, the criteria for the return to a non-defaulted status, etc. On the other hand, the RTS specify the conditions that competent authorities shall apply when setting the materiality threshold.
Scope of application
Credit institutions and investment firms (institutions) under the scope of the CRR, with regard to the definition of default used for the purpose of the Standardised Approach for credit risk and the IRB Approach.
Guidelines on the application of the definition of default:
- Past due criterion. The Guidelines clarify aspects with regard to the counting of days past due, the technical past due situation, etc.
- Indications of unlikeness to pay (UTP). Guidance is provided regarding the application of each indication (bankruptcy, distressed restructuring, etc.).
- Application of the definition of default in external data. Certain requirements are specified for institutions that use the IRB Approach and use external data for the purpose of estimating risk parameters.
- Criteria for the return to a non-defaulted status. The probation period and the minimum conditions for reclassification to a non-defaulted status are specified (including specific rules applying to exposures subject to distressed restructuring).
- Consistency. It is specified that institutions should identify the default of a single obligor consistently, and also that institutions may use different definitions of default for certain types of exposures, although differences have to be justified.
- Definition of default for retail exposures. The guidelines clarify aspects with regard to the level of application (e.g. credit facility level).
- Documentation and internal governance. The guidelines include some documentation requirements, and also governance requirements for IRB institutions.
RTS on the materiality threshold:
- Materiality threshold. Competent authorities are required to set a threshold for retail and for ‘non-retail’, which will apply to all institutions in a given jurisdiction. The RTS require that this threshold is composed of both an absolute and a relative threshold.
Download the technical note by clicking here.