Accompanying document

Article 123(1) of Regulation (EU) No 575/2013 as amended by Regulation (EU) 2024/1623 (CRR) mandates the EBA to issue Guidelines to specify proportionate diversification methods under the Standardised Approach for credit risk under which the exposure should be considered as one of a significant number of exposures with similar characteristics; satisfactory diversification is one of the mandatory criteria set out under Article 123(1) of the CRR to be fulfilled for the application of a preferential risk weight of 75%.⁹

As per Article 16(2) of the ESAs regulation (Regulation (EU) No 1093/2010, (EU) No 1094/2010 and (EU) No 1095/2010 of the European Parliament and of the Council), any guidelines developed by the ESAs should be accompanied by an Impact Assessment in the A nnex which analyses ‘the potential related costs and benefits’ of the Guidelines. Such Annex should provide the reader with an overview of the findings as regards the problem identification, the options identified to remove the problem and their potential impacts.

The EBA has prepared the Impact Assessment contained in the Guidelines, which analyses the policy options considered. Given the nature of the topic, the Impact Assessment is qualitative, and the limited data received during the consultation is not considered representative of the European context.

⁹ Except 1) transactor exposures, which are assigned a risk weight of 45% and 2) exposures due to loans granted by an institution to pensioners or employees with a permanent contract against the unconditional transfer of part of the borrower’s pension or salary to that institution, which are assigned a risk weight of 35% when meeting the conditions set out in Article 123(5) of the CRR (Regulation (EU) No 575/2013 of the European Parliament and of the Council of 26 June 2013 on prudential requirements for credit institutions and investment firms and amending Regulation (EU) No 648/2012 (OJ L 176, 27.6.2013, p. 1, ELI: http://data.europa.eu/eli/reg/2013/575/oj).

The Basel III international accords determine the ‘ diversification condition ’ for retail exposures eligible to the 75% preferential risk weight as the ‘g ranularity criterion ’ , where it is noted that no aggregate exposure to one counterparty can exceed 0.2% of the overall portfolio excluding defaulted exposures, unless the national supervisor has determined another method to ensure satisfactory retail diversification.

To retain the possibility that institutions which do not hold a granular enough retail portfolio can still apply the preferential risk weight, a diversification test is introduced that allows an objective quantitative assessment of no material correlation. The diversification test in its final, simplified version can be seen as a granularity test with additional flexibility, which does not impose significant additional burden on institutions, as it is based on already available information. In practice, institutions simply are to compare the share of their retail exposures that exceed the 0.2% granularity criterion to a pre-specified threshold.

Larger institutions can be in a better position to have less concentrated retail portfolios, in case retail exposures are a relevant part of the business activities of this institution, and in such case are expected to meet the 0.2% granularity criterion more easily compared with smaller institutions. Thus, diversification concerns are limited for larger retail portfolios, and the introduced measure is of particular relevance and provides flexibility for those institutions with retail portfolios with obligors for which the total amount owed by all these obligors or groups of connected clients to the institution, its parent and its subsidiaries (other than for RRE) is lower than EUR 500 million.

The main objective of these guidelines is to provide harmonised guidance at European level for appropriate retail diversification methods that are required to fulfil the mandatory criterion for satisfactory diversification for an exposure to be granted a preferential risk weight treatment and ultimately achieving a level playing field across the EU. In particular, this instrument should retain the possibility also for institutions that are not holding a granular enough retail portfolio to apply the preferential retail risk weights to that part of the portfolio, which is sufficiently diversified.

In preparing the present guidelines, the EBA considered two policy options:

• a. non-iterative process: Multiplying 0.2% by the sum of the exposure values of those exposures belonging to the original portfolio (i.e. to the portfolio without excluding any large) exposures);
• b. iterative process: Multiplying 0.2% by the sum of the exposure values of those exposures belonging to the final portfolio that is being assessed (i.e. the original portfolio after excluding any (large) exposures).

Taking into account proportionality and ensuring strict prudential standards, the assessment considers (i) operational practicability, (ii) risk management incentives, and (iii) comparability across institutions.

Under option a., exposures exceeding the 0.2% granularity criterion are retained in the denominator. The removal of exposures that exceed the 0.2% granularity criterion from the portfolio therefore automatically leads to satisfactory diversification. By applying a non-iterative process, the granularity criterion is only verified once, which avoids circular calculations as the denominator always refers to the original portfolio from which no exposures have been removed. I. Concerning (i): this option can be considered as a proportionate and harmonised approach toward ensuring satisfactory retail diversification.

II. Concerning (ii): from a risk management perspective, this approach could incentivise the construction of artificially large non-granular retail exposures that inflate the denominator as reference is only made to the original portfolio. While incentives for such practices could be limited to a certain extent as the institution would have to bear the cost of such artificial exposure inflation in terms of RWEA, these capital costs might, however, rather not be sufficient for discouraging this regulatory arbitrage, due to being relatively minor compared to the reduction in capital costs for the difference between a 100% risk weight and the preferential retail risk weight, in particular if unconditionally cancellable commitments with only 10% conversion factor are used for this purpose.

III. Concerning (iii): from a comparability perspective, the approach would treat the same portfolios differently for different banks, depending on the existence of excluded exposures, as the reference is always to the original portfolio. While excluding large eligible retail exposures allows bank A to treat the whole remaining portfolio as sufficiently diversified, this remaining portfolio might be identical with the original portfolio of another bank B which, however, would need to exclude additional large eligible retail exposures under option a.

Under option b., exposures exceeding the 0.2% granularity criterion are removed from the denominator. Put differently, the denominator is updated to reflect removed exposures and exposures, which will belong to the eligible retail portfolio. The removal of exposures that exceed the 0.2% granularity criterion from the portfolio does not necessarily lead to satisfactory diversification for the remaining portfolio. For this reason (i.e. updating the denominator), the iterative nature of this option comes into play to determine the retail exposures that are eligible for the preferential risk weight. Generally, it should be noted that, by construction, the resulting granularity is systematically higher with this option than with option a., as the denominator becomes smaller due to the iterative process.

I. Concerning (i): this option can also be considered as a proportionate and harmonized approach toward ensuring satisfactory retail diversification, but its implementation is more complex due to the iterative process. However, since this approach is also based solely on readily available information, the additional burden can be deemed relatively modest.

II. Concerning (ii) and (iii): from a risk management and comparability perspective, this option does not incentivise an artificial inflation of exposures and treats the same portfolios equally as the denominator takes into account the excluded exposures. Following also the feedback received during the consultation, the retained option is option a., as it provides a proportionate, operationally simple, and harmonised approach, while still ensuring satisfactory retail diversification with acceptable prudential safeguards for exposures to be granted a preferential risk weight of 75% as set out under Article 123(1) of the CRR.

The EBA publicly consulted on the draft proposal contained in this paper. The consultation period lasted for three months and ended on 12 February 2025. Thirteen answers have been received on a non-confidential basis, which were published on the EBA website, and one on a confidential basis.

This paper presents a summary of the key points and other comments arising from the consultation, the analysis and discussion triggered by these comments and the actions taken to address them if deemed necessary.

In many cases several industry bodies made similar comments, or the same body repeated its comments in the response to different questions. In such cases, the comments and EBA analysis are included in the section of this paper where EBA considers them most appropriate.

Following the responses received during the public consultation, the draft has been revised to move from the iterative approach to the one-step approach, which is considered, among other things, simpler to implement. In addition, the threshold has been increased, from 5% to 10%, compared to the consultation phase, in order to alleviate the impact on small and medium-sized institutions. Summary of responses to the consultation and the EBA’s analysis