evelyne-ngnote

1.  Changes to the standard approach to credit risk generally in line with the Basel Committee

1.1.    Revision of the standard approach to credit risk to improve risk sensitivity

The Standardised Approach for Credit Risk (SA-CR) is used by the majority of EU banks to calculate capital requirements for their credit risk exposures. In addition, the SA-CR should serve as a credible alternative to, and an effective backstop for, the internal model approaches.

The current SA-CR has proven to be insufficiently risk sensitive in a number of areas, sometimes leading to an inaccurate or inappropriate measure of credit risk (too high or too low) and, consequently, to an inaccurate or inappropriate calculation of capital requirements. .

The revision of the SA-CR increases the risk sensitivity of this approach in several key areas.

1.2.   A more granular framework for applying the CCF, in line with the finalisation of Basel III.

The finalisation of Basel introduced a number of changes in the way banks must determine the exposure value of off-balance sheet items and off-balance sheet commitments.

CRR3 aligns the credit conversion factors (“CCFs”) applicable to off-balance sheet exposures with the Basel III standards, introducing two new CCFs of 40% and 10%, respectively, and removing the 0% CCF. The treatment of off-balance sheet exposures is also clarified with respect to the applicable CCFs for determining their exposure value.

An exemption introduced in CRR3, in line with the finalization of Basel III, will however allow banks to continue to apply a 0% CCF to specific contractual provisions for companies, including SMEs, that are not classified as “commitments”.

CRR3 also introduces a transitional period during which banks are allowed to apply a 0% CCF to unconditionally terminable liabilities until 31 December 2029.

After that date, the incremental CCF will be phased in over the next three years, with the CCF at the end of the phase-in period reaching 10 %. This transitional period will allow EBA to assess whether the impact of a 10% CCF for these commitments would not lead to unintended consequences for certain types of obligors that rely on these commitments as a flexible source of funding. On the basis of this assessment, the Commission will have to decide whether to submit a legislative proposal to the European Parliament and the Council to amend the CCF to be applied to unconditionally terminable commitments.

The classification of off-balance sheet items is modified in accordance with the revised Basel III standards to better reflect the grouping of these items into categories based on the applicable CCFs.

1.3.   Evolution of the treatment of exposures to institutions in line with the finalisation of Basel III.

1.3.1.    Two new standard approaches to credit risk for institutions: ECRA and SCRA

The finalization of Basel III changed the current treatment of bank exposures, introducing the Standardized Approach to Credit Risk Assessment (SCRA) alongside the existing External Credit Risk Assessment (ECRA).

  • ECRA relies on external credit risk assessments (i.e. credit ratings) provided by eligible credit rating agencies (ECAIs) to determine the applicable risk weights.
  • Under the SCRA, banks are required to classify their exposures to banks into one of three categories (“grades”).

1.3.2.    The ECRA approach is prescribed for exposures rated

CRR3 aligns with the finalization of Basel III by lowering the risk weight applicable to exposures to banks for which a Level 2 credit quality assessment by a designated ECAI is available. It also includes in the scope of short-term exposures those resulting from the movement of goods across national borders with an original maturity of six months or less.

1.3.3.    The SCRA approach is prescribed for unrated exposures

CRR3 introduces the SCRA for exposures to banks for which no credit assessment by a designated ECAI is available. This approach requires banks to classify their exposures to these banks into one of three categories based on several quantitative and qualitative criteria. In order to avoid a mechanistic application of the criteria, banks are subject to due diligence requirements for exposures to banks for which a credit assessment by a designated ECAI is not available when assigning the applicable risk weight.

This ensures that capital requirements appropriately and prudently reflect the creditworthiness of banks’ counterparties, whether or not they are externally rated.

1.3.4.    Removal of the option to weight bank exposures according to sovereign ratings

In line with Basel III standards, the current option of weighting bank exposures according to their sovereign ratings is removed to break the link between banks and their sovereigns. This also applies to rated banks by prohibiting credit assessments by a designated ECAI from incorporating assumptions of implicit government support, unless the ratings refer to public sector banks.

1.4.   A change in the treatment of corporate exposures in order to mitigate the potential deleterious impact of the output floor on the financing of non-rated companies

1.4.1.    The risk that the Output Floor poses to the financing of unrated companies

CRR3 aligns with the finalization of Basel III to reduce the risk weight applicable to exposures to companies for which a Level 3 credit quality assessment by a designated ECAI is available.

With the implementation of the Output Floor, banks using internal models to calculate capital requirements for corporate exposures must also apply the SA-CR, which relies on external ratings to determine the credit quality of the borrowing firm.

However, most EU firms do not generally seek external credit ratings, due to the cost of establishing a rating and other factors. Given that the capital requirements calculated under the SA-CR are, on average, more conservative for unrated firms than for rated firms, the implementation of the Output Floor could lead to substantial increases in capital requirements for banks using internal models.

1.4.2.    Progressive and moderate application of the output floor to the exposures of unrated companies

In order to avoid disruptive effects on bank lending to unrated companies and to allow sufficient time for public and/or private initiatives to increase credit rating coverage, CRR3 is adapted accordingly. It provides for a specific transitional regime for exposures to unrated companies when calculating the output floor. During the transitional period, banks are authorized to apply a preferential risk weight of 65% to their exposures to companies that do not have an external rating, provided that these exposures have a probability of default (PD) of less than or equal to 0.5% (this corresponds to an investment grade rating). This treatment applies to all unrated companies, whether listed or not.

1.4.3.    The supervisory role of the EBA

EBA shall monitor the use of transitional treatment and the availability of credit assessments by designated ECAIs for corporate exposures. EBA will be required to monitor the use of transitional treatment and to prepare a report on the appropriateness of its calibration. On the basis of this report, the Commission will have to decide to submit a legislative proposal to the European Parliament and the Council on the treatment of exposures to unrated high credit quality corporates.

1.5.  The creation of the Specialised lending exposure class

1.5.1.    The importance of promoting specialized lending in the EU

The promotion of viable infrastructure and other specialized projects is of vital importance to the Union’s economic growth. Specialized lending by institutions is also a defining feature of the EU economy, compared to other jurisdictions where such projects are mainly financed through capital markets. The large EU-based institutions are important providers of finance for specialized projects, object finance and commodity finance, both within the Union and globally, and as such have developed a high level of expertise in these areas.

1.5.2.    The implementation of the RWA calculation framework for specialized lending

In line with Basel III standards, CRR3 introduces a specialized lending exposure class as well as two general approaches for determining the risk weights applicable to specialized exposures, one for externally rated exposures and one for exposures that are not externally rated.

Project finance, object finance and commodity finance exposure categories are introduced in the SA-CR framework, in line with the same three sub-categories in the internal ratings-based (IRB) approaches.

1.5.3.    A granular approach to weightings for unrated specialised finance exposures more sirk sensitive than that of the Basel Committee

As the new standardized treatment under Basel III for unrated specialized loan exposures is not sufficiently risk sensitive to reflect the effects of the full securities packages typically associated with certain object finance exposures in the Union, additional granularity is introduced in the SA-CR for these exposures.

Unrated object finance exposures that benefit from prudent and conservative management of the associated financial risks by complying with a set of criteria capable of lowering their risk profile to a “high quality” standard receive favourable capital treatment compared to the general treatment of unrated object finance exposures under Basel III. The determination of what constitutes “high quality” for object financing is subject to further specific conditions to be developed by the EBA through draft regulatory technical standards.

The preferential treatment introduced in CRR II to encourage bank financing and private investment in high quality infrastructure projects (“infrastructure support factor”) is maintained in both the SA-CR and IRB approaches for credit risk with targeted clarifications, resulting in lower capital requirements for infrastructure projects than the specific treatment under Basel III. However, the preferential treatment under CRR3 for “high quality” project finance exposures will only apply to exposures to which banks do not already apply the “infrastructure support factor” treatment in order to avoid an unwarranted reduction in their capital requirements.

1.6.   Evolution of the treatment of retail exposures in line with the Basel Committee

CRR3 aligns the classification of retail exposures under SA-CR with the classification under the IRB approaches to ensure consistent application of corresponding risk weights to the same set of exposures in line with the finalization of Basel III.

CRR3 also introduces a preferential 45% risk-weight treatment for revolving retail exposures that meet a set of repayment or usage conditions that may reduce their risk profile, defining them as exposures to “transactors”, in line with the finalization of Basel III.

Exposures to one or more natural persons that do not qualify as retail exposures shall be assigned a 100 % risk weight.

1.7.  Changes in the treatment of exposures with currency mismatches in line with the Basel Committee

CRR3 introduces a risk weight multiplier requirement for unhedged residential and commercial real estate exposures to individuals where there is a mismatch between the currency of denomination of the loan and that of the debtor’s source of income.

As indicated in the Basel III finalization, the multiplier is set at the level of 1.5, subject to a cap on the resulting final risk weight of 150%.

Where the currency of exposures is different from the domestic currency of the debtor’s country of residence, banks may use all unhedged exposures as a proxy.

1.8.   changes in the treatment of exposures secured by real estate, with the introduction of the concepts of IPRE and ETV

1.8.1.    A general framework in line with the completion of Basel III

In line with the finalization of Basel III, the treatment of the real estate exposure class is modified to further increase the granularity with respect to the inherent risk posed by different types of real estate transactions and loans.

The new risk weighting treatment maintains the distinction between residential and commercial mortgages, but adds additional granularity based on the type of financing of the exposure (dependent or not on the income stream generated by the secured property) and on the phase in which the property is located (construction phase vs. finalized property).

1.8.2.    Introduction of the concept of IPRE: Income-producing real estate more risky than real estate whose repayment depends on the borrower’s income

A new development is the introduction of a specific treatment of income-producing real estate mortgages (IPRE), i.e. mortgages whose repayment is materially dependent on the cash flows generated by the property securing these loans. Evidence gathered by the Basel Committee shows that these loans tend to be significantly riskier than mortgages whose repayment is materially dependent on the underlying ability of the borrower to service the loan.

However, under the current SA-CR framework, there is no specific treatment for these riskier exposures, even though this dependence on the cash flows generated by the property securing the loan is a significant risk factor. The lack of specific treatment may result in insufficient levels of capital requirements to cover unexpected losses on such property exposures.

Thus in CRR3, several definitions are amended, replaced or newly inserted to clarify the meaning of the different types of exposures secured by mortgages on real estate by clearly distinguishing exposures secured by mortgages on residential real estate and commercial real estate, respectively, including for IPRE mortgages (residential and commercial).

1.8.3.    Evolution of the residential property treatment framework with the introduction of the ETV

CRR3 aligns with the provisions of the Basel III finalization with respect to exposures secured by mortgages on residential property. While the loan splitting approach, which divides mortgage exposures into a secured and an unsecured portion and assigns the corresponding risk weight to each of these two portions, is retained, its calibration is adjusted in line with the Basel III standards whereby for the secured portion of the exposure, up to 55% of the value of the property receives a 20% risk weight. This calibration of the risk weight for the secured part addresses the situation where the bank may incur additional unexpected losses, even beyond the haircut that is already applied to the value of the property when sold in the event of a debtor default.

In addition, CRR3 provides for a more risk-sensitive fallback treatment based on the exposure-to-value (ETV) ratio for residential mortgages where the property is not eligible for loan splitting (e.g. because it is not completed).

CRR3 also provides for a specific and more granular risk weighting treatment that applies to residential EWPI exposures.

1.8.4.    Evolution of the framework for dealing with commercial property with the introduction of ETV

Conceptually, the treatment of commercial real estate mirrors the treatment of residential real estate exposures: the well-established approach to loan splitting is maintained and its calibration is adjusted in line with Basel III standards whereby the secured portion of the exposure up to 55% real estate value receives a 60% risk weight. In addition, CRR3 provides for a more risk sensitive fallback treatment based on the ETV ratio for commercial mortgages where the property is not eligible for loan splitting.

A dedicated and more granular risk weighting treatment for IPRE commercial exposures is introduced while retaining the test, which allows banks to apply the same preferential risk weights to income-generating and other commercial real estate exposures secured by property located in markets where annual loss rates do not exceed certain thresholds

1.8.5.    ETV calculation methods more sensitive to real estate market developments than the initial Basel Committee proposal

In order to reduce the impact of cyclical effects on the value of a property securing a loan and to keep capital requirements for real estate lending more stable, the final Basel III standards cap the value of the property recognized for supervisory purposes at the value measured at loan origination, except for changes that “unequivocally” increase the value of the property.

At the same time, the standards do not require banks to monitor the development of real estate values. Instead, they only require adjustments in the event of extraordinary events.

In contrast, the current SA-CR applicable in the EU obliges banks to regularly monitor the value of the collateral. On the basis of this monitoring, banks are required to make upward or downward adjustments to the property (regardless of the value of the property at loan origination).

CRR3 is adapted to reduce the impact of cyclical effects on the valuation of real estate loans securing loans and to keep capital requirements for real estate loans more stable. In particular, the current requirement for frequent monitoring of real estate values is maintained, allowing for an upward revision beyond the value at loan origination (contrary to Basel III standards), but only up to the average value over the past three years in the case of commercial real estate and over the past six years in the case of residential real estate.

For real estate pledged as collateral for covered bonds, it is clarified that the competent authorities may allow banks to use the market value or the value of mortgages without limiting increases in real estate value to the average over the last three or six years, respectively. In addition, modifications to the property that improve the energy efficiency of the building or dwelling should be considered as unequivocally increasing its value.

Finally, institutions are allowed to perform property valuation and revaluation using statistical or other advanced mathematical methods, developed independently of the credit decision process, subject to compliance with a number of conditions, which are based on the EBA guidelines on loan origination and monitoring (EBA/GL/2020/06), and subject to supervisory approval.

CRR3 provides for a specific transitional regime for low-risk exposures secured by mortgages on residential property in the Output Floor. During the transitional period, Member States may allow banks to apply a preferential risk weight of 10% to the secured part of the exposure up to 55% of the value of the property, and a risk weight of 45% to the remaining part of the exposure up to 80% of the value of the property, provided that certain conditions are met to ensure that they are low-risk, and verified by the competent authority

1.9.   Evolution of the treatment of subordinated debt exposures in line with the Basel Committee

CRR3 implements the revised treatment of subordinated debt exposures provided for by the finalization of Basel III (i.e. a 150% risk weight).

1.10.  Evolution of the treatment of equity exposures in line with the Basel Committee

CRR3 aligns with the finalization of Basel III on the revised treatment of equity exposures. The scope of the equity exposure class is clarified by providing a definition of equity exposures and specifying which other instruments should be classified as equity exposures for the purpose of calculating credit risk-weighted assets.

To increase the risk sensitivity of the SA-CR, the revised risk weights reflect the higher downside risk of equities relative to debt exposures via a 250% risk weight and differentiate between longer-term speculative and riskier investments which are assigned a 400% risk weight.

In order to avoid undue complexity, the classification of long-term exposures refers to the holding period approved by the bank’s senior management as the central criterion.

Equity exposures incurred under legislative programs to promote specific sectors of the economy that provide significant investment subsidies to the institution and involve some form of government oversight may be assigned a 100 percent weight, subject to a 10 percent threshold of the institution’s own funds and oversight approval. These grants may also take the form of blanket guarantees by multilateral development banks, public development credit institutions and international organizations. This is to reflect the fact that the European Investment Bank Group, multilateral development banks, public development banks and Member States are putting in place such “legislative programmes”, often based on general government guarantees and linked to financial recovery and resilience plans, to leverage private capital, including in support of strategic enterprises.

Equity exposures to central banks remain at 100% weighting.

Finally, CRR3 provides a floor for equity exposures that are recorded as a loan but result from a debt/equity swap carried out as part of the orderly realization or restructuring of debt: in line with the finalization of Basel III, the applicable risk weight must not be lower than the risk weight that would apply if the holdings remained in the debt portfolio.

1.11.  Evolution of the treatment of defaulted exposures in line with the Basel Committee

CRR3 clarifies the risk-weighting treatment of haircuts on purchases of non-performing exposures (NPEs), as announced in the EU Communication to combat non-performing loans in the aftermath of the COVID-19 pandemic. Thus CRR3 clarifies that banks may take into account the haircut on purchased defaulting assets when determining the appropriate risk weight to be applied to the defaulting exposure. This complements the ongoing work of the EBA to amend the RTS on credit risk adjustments.

1.12.  Use of credit assessments by external credit assessment institutions and mapping

In order to inform any future initiative on the establishment of public or private rating systems, CRR3 mandates the European Supervisory Authorities (ESAs) to prepare a report on the barriers to the availability of external credit ratings by ECAIs, in particular for corporates, and on possible measures to address them.

2.  Developments in the irb approach broadly in line with the Basel Committee

2.1.   Reduction of the irb perimeter in order to reduce the unjustified variability of rwas between banks

Capital requirements for credit risk based on banks’ internal models have important advantages in terms of risk sensitivity, banks’ understanding of their risks and the level playing field between EU banks.

However, the financial crisis has highlighted important shortcomings in IRB approaches. A series of studies at both international and EU level have revealed an unacceptable variation in capital requirements between banks, which cannot be explained solely by differences in the riskiness of banks’ portfolios. This undermines the comparability of capital ratios and affects the possibility of fair competition between institutions. In addition, the crisis has revealed instances where the losses incurred by institutions on certain portfolios were significantly higher than the model predictions, resulting in insufficient levels of capital held by individual institutions.

The applicable framework contained insufficient limitations on the availability of IRB approaches for difficult-to-model exposure classes. In addition, the framework required banks that intended to use the IRB approach for some of their exposures to deploy the IRB approach on all exposures.

The various changes introduced in CRR3 will limit the use of advanced modelling approaches and should eliminate a significant source of excessive variability in RWAs and thus improve the comparability of capital requirements. In addition, it will remove an unnecessary source of complexity from the framework.

CRR3 limits the exposure classes for which internal models can be used to calculate capital requirements for credit risk, implementing the Basel III standards. Specifically, the use of the Advanced IRB Approach (IRBA), which allows for the modelling of all risk parameters, is only allowed for those exposure classes for which robust modelling is possible while other exposure classes are “migrated” to less sophisticated approaches. Thus, the use of the IRBA approach is no longer available for the exposures below. Banks can use the foundation IRB approach (IRBF) and thus model only the PD:

  • 500 millions or belonging to a group whose total annual consolidated group turnover exceeds.
  • Exposures to banks and other financial sector entities (including those treated as corporates).

In addition, the IRB approach is no longer available for equity exposures.

2.2.   Introduction of a New Exposure Class (PSE- RGLA) for regional and local governments and public sector entities

Currently, exposures to public sector entities and to regional and local governments can be treated either as exposures to central governments or as exposures to banks:

  • Those treated as exposures to banks must be migrated to the IRBF approach according to the finalization of Basel III. They will therefore be subject to the modelling constraints presented above.
  • Exposures treated as central government exposures would not be treated as such.

In order to reduce the excessive complexity of the framework, to ensure consistent treatment of exposures to public sector entities and regional governments and to avoid unintended variability in the corresponding capital requirements, it is proposed to create a new exposure class “PSE-RGLA” to which all exposures to these entities will be assigned regardless of their current treatment as sovereign or bank exposures. The same rules will apply to these exposures as to the general corporate exposure class.

In particular, the entry thresholds applicable to corporate exposures will apply in the same way to exposures belonging to the PSE-RGLA exposure of the Basel III class.

2.3.   Introduction of Inputs floors on irb parameters

CRR3 introduces the concept of input floors. These are the minimum values for internal IRB parameters that are used as inputs for the calculation of RWAs (“input floors”). These input floors serve as safeguards to ensure that capital requirements do not fall below sufficiently conservative levels, mitigating model risk, measurement error, data limitations and improving the comparability of capital ratios between banks.

For the PD risk parameter, the existing entry thresholds are slightly increased (from 0.03% under Basel II to 0.05% under Basel III). On the other hand, for the LGD and CCF risk parameters, the entry thresholds are new, conservatively calibrated requirements. The LGD entry threshold for unsecured corporate exposures is set at 25% and for general unsecured retail exposures at 30%. A formula including conservative haircuts by collateral type is provided for secured exposures, while the IRB-specific CCF entry floor is set at the 50% of the applicable CCF standard approach.

2.4.   Exemption of input floors on sovereign exposures

CRR3 specifies, in line with the finalization of Basel III, that the new input floors are not applicable to sovereign exposures.

2.5.   Removal of the scaling factor of 1.06 in the calculation of RWA

CRR3 removes the 1.06 scaling factor that applies to credit risk-weighted exposure amounts under the IRB approaches, thereby simplifying the calculation and cancelling the 6% calibration increase in IRB risk weights that apply under the current framework.

2.6.   Removal of “double default” processing

CRR3 removes the double default method for certain collateralized exposures, leaving only one general formula for calculating risk weights and simplifying the framework, as foreseen by the finalization of Basel III. With fewer embedded options, the revised calculation ensures greater comparability of RWAs across institutions and a reduction in undue variability.

2.7.   More flexible roll OUT AND ppu irb expectations leading to an “A la carte” irb device

As part of the finalization of Basel III, a bank’s adoption of the IRB approaches for an exposure class is no longer conditional on all exposure classes in its banking book eventually being treated according to the IRB approach (“IRB roll out”), with the exception of exposures for which a permanent partial use (PPU) of the SA-CR is authorized by the regulations and approved by the competent authority

This new principle is implemented in CRR3, allowing banks to apply the IRB approaches selectively.

In order to ensure a level playing field between banks that currently treat their exposures using one of the IRB approaches and those that do not, transitional provisions are set out in CRR3. CRR3 allows banks to revert to the SA-CR for a period of three years subject to approval by the competent authorities under a simplified procedure.

2.8.   New LGD PARAMETER values in the IRBF framework

CRR3 implements recalibrated LGD values for senior unsecured corporate exposures (LGD of 40% instead of 45%). The LGD value for dilution risk of purchased corporate receivables is also modified to be aligned with the Basel III finalization treatment.

2.9.   Evolution of the perimeter and calculation methods of the CCF models

CRR3 revises the scope and modelling of CCFs. In particular, the new provisions require the use of a fixed period of 12 months prior to default to estimate CCF models, and allow the use of internal CCF models only for specific exposures for which the corresponding standardized CCF is less than 100%.

2.10.  Guarantees provided by protection providers treated according to the least sophisticated approach in line with the substitution principle

The finalization of Basel III significantly revised the methodologies that banks are allowed to use to recognize the risk mitigating effects of eligible collateral with a view, inter alia, to limiting the range of approaches and thus reducing the variability of capital requirements. To this end, Basel III generally provides that the risk weight to be applied to the secured portion of the exposure should be that calculated under the approach applied to comparable direct exposures to the protection provider.

  • Where an exposure treated under Approach IRBA is guaranteed by a guarantor that is treated under Approach IRBF or SA-CR, recognition of that guarantee shall result in the guaranteed exposure being treated under Approach IRBF or SA-CR, respectively.

Recognition of collateral in the IRBA approach will have to be done using one of the following approaches:

  • Substitution of the risk weight approach by substituting the debtor’s risk weight with the guarantor’s risk weight if comparable direct exposures to the guarantor are treated under the SA-CR.
  • The risk parameter substitution approach, substituting the debtor’s risk parameters with the risk parameters associated with comparable direct exposures to the guarantor if comparable direct exposures to the guarantor are treated under the IRB approach.
  • Adjustment of LGD or estimates of both PD and LGD: under this approach, CRR3 specifies that the recognition of a guarantee must never lead to a risk weight applicable to the guaranteed exposure that is lower than that of an approach comparable to a direct exposure to the guarantor.

This is to preserve the consistency of the framework in terms of risk assessment, avoiding that an indirect exposure to a particular protection provider can be assigned a lower risk weight than a comparable direct exposure where the same protection provider is the obligor.

2.11.    Treatment of Specialised Loan Exposures under the IRBA approach with the phased introduction of input floors on PD and LGD

The new modelling restrictions introduced by the finalization of Basel III are relatively limited with respect to the treatment of specialized lending exposures under the IRB approaches.

Although input floors apply, the IRBA approach remains possible regardless of the size of the obligor, unlike the treatment applicable to other corporate exposures. However, the new input floors for corporate exposures also apply to specialized lending exposures without taking into account specific lending practices that involve specific safeguards to mitigate credit risk.

Therefore, CRR3 progressively introduces the new input floors, starting with a discount factor of 50% which gradually increases to 100% over a period of 5 years.

In addition, the CRR3 mandates the EBA to assess the adequacy of the PD and LGD input floors applicable to specialized lending exposures and empowers the Commission to revise the parameters by a delegated act on the basis of the EBA’s assessment.

2.12.  Enabling clauses for leasing exposures and credit insurance

A high level of expertise and risk management has been developed by EU institutions in the area of leasing, as well as in the use of credit insurance, in particular for trade finance purposes. In the absence of sufficient data, it remains unclear whether the new risk parameters are appropriately calibrated to reflect the risk mitigating effect of the leasing guarantee and, respectively, what characteristics credit insurance policies must have to be recognised as eligible credit protection.

Therefore, CRR3 mandates EBA to assess the appropriateness of the calibration of parameters applicable to leasing exposures, in particular the new collateral haircuts (“volatility adjustments”) and the regulatory values for collateralised LGDs. The Commission is empowered to revise the calibration by a delegated act, if appropriate, taking into account the EBA report. In the meantime, a 5-year phase-in period applies to the new risk parameters under the IRBA approach.

In addition, EBA will have to report to the Commission on the eligibility and use of credit insurance as a credit risk mitigation technique and on the appropriate risk parameters to be associated with it in the framework of the SA-CR and IRB approach of the Foundation. On the basis of that report, the Commission is required to present, if appropriate, a legislative proposal on the use of credit insurance as a credit risk mitigation technique.

3.  Developments in credit risk mitigation techniques

CRR3 aligns with the finalization of Basel III with respect to the consideration of collateral and guarantees under the SA-CR and IRBF approaches. In particular, the supervisory haircuts applicable to financial collateral under the Comprehensive Financial Collateral Approach have been revised, as have the values of collateralized LGDs and the collateral haircuts applicable to exposures treated under IRBF.

CRR3 clarifies the eligibility criteria for guarantees and, respectively, guarantees provided under mutual guarantee schemes or provided or counter-guaranteed by certain entities. In particular, these clarifications should provide more detail on the eligibility as credit risk mitigation techniques of public guarantee schemes set up in the context of the COVID-19 crisis.

 

4.  References

https://ec.europa.eu/finance/docs/law/211027-proposal-crr-2_en.pdf

 

Abbreviations and glossary

EBA: European Banking Authority.

CCF: Credit Conversion Factor.

ECAI: External Credit Assessment Institution.

ECAI: Eligible Credit Assessment Institution.

LGD: Loss given default.

PD: Probability of default.

PPU: Partial Permanent Use.