159. The estimation referred to in paragraph 158(b) should comply with the following principles …

The estimation referred to in paragraph 158(b) should comply with the following principles:

• (a) for the purpose of estimation of the future costs and recoveries institutions should analyse the costs and recoveries realised on these exposures until the moment of estimation, in comparison with the average costs and recoveries realised during a similar period of time on similar exposures; for this purpose institutions should analyse the recovery patterns observed on both closed and incomplete recovery processes, taking into account only costs and recoveries realised up to the moment of estimation;
• (b) the assumptions underlying the expected future costs and recoveries as well as the adjustment to the observed average LGD should be:
• i. proven accurate through back-testing;
• ii. based on a reasonable economic rationale;
• iii. proportionate, taking into consideration that LGD estimates should be based on the long-run average LGD that reflects the average LGDs weighted by the number of defaults using all defaults observed during a historical observation period.
• (c) in estimating the future recoveries institutions should take into account the potential bias stemming from incomplete recovery processes being characterised by longer average recovery processes or lower average recoveries than closed recovery processes;
• (d) in estimating the future recoveries stemming from the realisation of the existing collaterals institutions should take into account the legal certainty of the claims on the collateral and realistic assumptions regarding the possibility of its realisation;
• (e) the adjustment of the observed average LGD may be estimated at the level of individual exposures, at the level of grade or pool or at the level of portfolio covered by the LGD model;
• (f) any uncertainty related to the estimation of the future recoveries on incomplete recovery processes should be reflected in an adequate MoC applied in accordance with section 4.4.

1. Overview

1.1 References

1.2 Identified Requirements

1.3 Related Standards

2. Identified Requirements

3. Related Standards

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