Treatment of fees, interest and additional drawings after default

With regard to the treatment of fees, interest after default and additional drawdowns after default (referred to in the CRR as additional drawings), it was considered that, to reflect correctly the level of loss, these should also be included in the calculation up to the moment of default. Therefore, all fees and interest outstanding at the moment of default should be included in the amount of outstanding obligation at the moment of default. In this sense, the treatment of fees and interests should be consistent, as the economic sense of these measures is similar, and whether the obligors in default are charged interest or fees may only depend on the institution’s pricing policy.

Furthermore, in specifying the treatment of additional drawings after the moment of default, it was considered that the resulting measure of realised LGD should be consistent with the exposure value that will be used for the purpose of calculation of capital requirements. Hence, where additional drawings after default are included in the conversion factors, the outstanding amount in the denominator of the realised LGD should also include such drawings. However, in the case of retail exposures, where the conversion factors do not include any drawings after the moment of default, the denominator of the realised LGD should also reflect only the outstanding amount at the moment of default. As a result, lower exposure value (based on lower conversion factors) will be compensated for by higher LGD.

Similarly, in the case of additional fees or interests that are capitalised after the moment of default, as these are generally not included in the conversion factors they should not increase the amount outstanding at the moment of default. It is also considered that, as such fees and interests are not related to outgoing cash flow, they should not increase the economic loss in the numerator of the realised LGD. However, where these additional fees cover costs that were incurred by the institution, these should be included in the calculation of economic loss as costs. It is assumed that the unrealised gains from fees and interest should not be considered losses if they are not related to any expenses incurred by the institution. However, recoveries on those items are profits realised by the institution and hence can decrease the economic loss. Therefore, all recovery cash flows realised on a given exposure should be included in the calculation of realised LGDs.

To keep consistency between the LGD and exposure value, including conversion factors, different calculation of the denominator of the realised LGD is proposed, depending on whether or not additional drawings after default are included in the estimation of conversion factors or not. However, this optionality does not refer to the measure of economic loss, i.e. the numerator of the realised LGD, as this should be an objective value that adequately reflects the actual value of loss experienced by the institution. As additional drawings after default are related to an outflow of cash from an institution, they should always be included in the calculation of economic loss in the numerator of realised LGD.

1. Overview

1.1 References

1.2 Identified Requirements

1.3 Related Standards

2. Identified Requirements

3. Related Standards

• EBA - Published by the European Banking Authority at https://www.eba.europa.eu/