Still 180 days past due?
Time to reconsider!
In December 2017, the European Banking Authority (EBA) advised the European Commission on the appropriateness of continuing to apply the 180 day past due exemption for defaulted recognition under IRB approach after 31 December 2019.
The Opinion is based on the findings from the EBA impact analysis on capital and capital ratio by switching from 180 days past due to 90 days past due criterion.
The removal of the 180 DPD criterion would lead to an increase in risk-weighted exposure amount (REA) in two thirds of the institutions that still make use of the 180 DPD criterion. The average expected relative change in REA is +1.61%. However, a wide variation in these numbers can be observed, reaching a maximum of +23.57 and a minimum of -20.30 percent (relative changes in RW).
The increases in REA can mostly be explained by the fact that the increase in PD has a greater (upward) effect than the decrease in LGD has on reducing the REA.
For some institutions, the decrease in the LGD parameter was constrained by the 10% floor on retail exposures secured by residential real estate. Without this floor, the increase in REA would naturally have been smaller, since the increase in the PD would have been counterbalanced by a larger decrease in the LGD estimate.
The average expected decrease is 0.37 percentage points in the capital ratio with significant variation across institutions. For all institutions, there is however a sufficiently large buffer above the minimum required capital ratio of 8%.
The largest downward expected effects on the capital ratio can be explained by:
- the wide applicability of the 180 DPD criterion;
- the fact that the expected increase in the PD estimate is not fully counterbalanced by a decrease in the LGD estimate;
- the increase in the IRB shortfall (i.e. leading to a larger deduction from Tier 1 capital).
The EBA recommends disallowing the continued application of the 180 DPD criterion after 31 December 2019 for all institutions and all exposures. This recommendation is based on the wide applicability of the 90 DPD criterion in the EU, the undue REA variability caused by the 180 DPD criterion and the forthcoming changes in the accounting framework.
However, it is acknowledged, that this recommendation may have a material capital impact on some institutions that currently use the 180 DPD criterion, and it is proposed that an appropriate transitional period would be justified, as well as individual supervisory plans should be developed to manage the process.
Deloitte can help you:
- Re-calibration of the internal risk parameters under the scenario where the 180 DPD provision is removed, in order to reflect the additional defaults and the changes in loss estimates;
- Re-development of the A-IRB models, taking into account the new requirements of the default definition in order to obtain optimal model that accurately reflects the observed loss.