6.3.2.2 Calculation of long-run average LGD

In accordance with letter (a) of Article 181(1) of Regulation (EU) No 575/2013 institutions are required to calculate the long-run average LGD separately for each facility grade or pool. In this context institutions should calculate the long-run average LGD also at the level of the portfolio covered by the LGD model. In the calculation of long-run average LGD institutions should use all defaults observed in the historical observation period that fall within the scope of the LGD model.

Without prejudice to Article 181(2) of Regulation (EU) No 575/2013 institutions should calculate the long-run average LGD as an arithmetic average of realised LGDs over a historical observation period weighted by a number of defaults. Institutions should not use for that purpose any averages of LGDs calculated on a subset of observations, in particular any yearly average LGDs, unless they use this method to reflect higher weights of more recent data on retail exposures in accordance with Article 181(2) of Regulation (EU) No 575/2013.

Where institutions do not give equal importance to all historical data for retail exposures in accordance with Article 181(2) of Regulation (EU) No 575/2013 they should be able to demonstrate in a documented manner that the use of higher weights for more recent data is justified by better prediction of loss rates. In particular where zero or very small weights are applied to specific periods this should be duly justified or lead to more conservative estimates.

In specifying the weights in accordance with paragraph 151 institutions should take into account the representativeness of data assessed in accordance with section 4.2.4 as well as the economic and market conditions that are represented by the data.