12. Source of PDs and LGDs

Where an institution has approved PD estimates or PD and LGD, estimates as part of the internal ratings based approach (IRBA) set out in Article 84 of directive 2006/48/EC, this data may be used as a source for obtaining PD and LGD estimates for IRC purposes, as well.

Where , in the latter cases, an institution does not have approved IRB PDs and/or LGDs or where IRB PDs and/or LGDs do not exist for an issuer or a security in the trading book, these should be computed using a methodology consistent with the IRB methodology, which would then require a separate approval by the competent authority for use in the IRC.

Risk neutral PDs should not be acceptable as estimates of observed (historical) PDs for the modelling of the rating migration or default. If PDs implied from market prices are used, the institution should do the relevant corrections to obtain the real measure probability from risk neutral probabilities, and it should compare the outcomes of its methodology against the historical record.

Alternatively, the use of PDs and LGDs provided by external sources (e.g. rating agencies) may also be used by institutions, as they are generally considered appropriate.

Institutions should establish a hierarchy ranking their preferred sources for their PDs and LGDs, in order to avoid the cherry-picking of parameters.