Monday, June 25, 2018

On June 22, the IIF submitted a response letter to the EBA’s Second Draft RTS on Economic Downturn, as well as the EBA’s Guidelines for the estimation of LGD appropriate for an economic downturn (‘Downturn LGD estimation’), submitted to the European Banking Authority.

We share the EBA’s view as presented in the Guidelines that “the strength of internal models lies in the ability of institutions to model on institution specific data, which ensures a high degree of risk sensitivity and constitutes an important characteristic of capital requirements to be maintained.” As such, we encourage the EBA to continue liaising with its international regulatory peers, and to escalate this RTS for consideration at Basel fora, in particular given the scope of the Basel III agreement. It is paramount in our view to align the EBA timelines with the implementation deadline of the Basel III final agreement (i.e. 2022 plus transition period).

Regarding the RTS, our main concern with the with the workability and implementation of this RTS is the level of complexity of retrieving all the information of the list of indicators required by Article 2. Secondly, we are concerned that data availability issues related to the requirement to look at a time series of 20 years for economic factors could increase the unjustified variability. Lastly, we support the EBA’s position of not creating specific guidelines for Downturn CF estimates. 

Regarding the Guidelines, the following themes were identified in our response:

  • There is a need for further detail on how to recognize the observed impact of downturn while also considering the relevant interactions with other estimation purposes (ELBE, IFRS9, Stress Test) in which economic conditions should be recognized. 
  • There is ambiguity in the interaction between downturn, model component, and attribution of the downturn effect at overall LGD level; therefore we deem relevant to disentangle the effect at model component level.
  • We consider that the total exposure amount which is treated with the policy proposed in Section 7 should remain immaterial. We view the 20% add-on as too conservative with a risk to over-estimate LGDs. 
  • We propose to replace the 20% add-on with the Reference Value approach, as it relies on internal loss data it is more adequate than an arbitrary forfeit value. The Reference Value approach can then be disregarded as a benchmark option. 
  • Finally, regarding the Reference Value approach as a benchmark, institutions would have the burden of proof to demonstrate potential misalignments with internally obtained results. We deem this consequence not appropriate, given the new Impact Assessment framework proposed. 

IIF Authors

Andrés Portilla

Andres Portilla - IIF
Managing Director, Regulatory Affairs

Natalia Bailey

Associate Policy Advisor