7.3.2.3 Relation of EL BE to specific credit risk adjustments

Where the model used for credit risk adjustments satisfies or can be adjusted to satisfy the requirements for own-LGD estimates set out in Part Three, Title II, Chapter 3, Section 6 of Regulation (EU) No 575/2013, institutions may use specific credit risk adjustments as EL BE estimates.

Where specific credit risk adjustments are assessed individually for a single exposure or a single obligor, institutions may override the EL BE estimates based on specific credit risk adjustments, where they are able to prove that this would improve the accuracy of the EL BE estimates and that the specific credit risk adjustments reflect or are adjusted to the requirements set in section 6.3.1 on the calculation of economic loss.

For the purposes of justifying situations where the specific credit risk adjustments exceed the EL BE estimates in accordance with Article 54(2)(f) of the RTS on IRB assessment methodology, institutions should ensure consistency of the EL BE estimates with the economic loss components described in section 6.3.1 as well as with the definition of default set out in Article 178 of Regulation (EU) No 575/2013 and analyse any differences in that regard from the definitions and methods used for the purpose of determining specific credit risk adjustments. In particular, institutions should take into account, the possible differences in the discounting rate, the presence of collateral that is not eligible under Article 181(1)(f) of Regulation (EU) No 575/2013, different treatments of costs and the application of different definitions of default.

7.3.3 Specific requirements for LGD in-default estimation

For the purpose of considering the possible adverse change in economic conditions during the expected length of the recovery processes referred to in Article 54(2)(a) of the RTS on IRB assessment methodology the LGD in-default should reflect at least downturn conditions, where the estimates of LGD in-default that are appropriate for an economic downturn are more conservative than the long-run average LGD for defaulted exposures, referred to in paragraph 180.

For the purpose of Article 181(1)(h) of Regulation (EU) No 575/2013 the LGD in-default should be increased above the level referred to in paragraph 189 where this is necessary to ensure that the difference between the LGD in-default and the EL BE covers for any increase of loss rate caused by possible additional unexpected losses during the recovery period.

For the purpose of ensuring that the LGD in-default is higher than the EL BE , or is in exceptional cases equal to the EL BE for individual exposures, in accordance with Article 54(2)(d) of the RTS on IRB assessment methodology institutions should analyse and correct the LGD in-default in those situations where the EL BE was obtained using specific credit risk adjustments, in accordance with paragraph 186, and is above the LGD in-default obtained through direct estimation in accordance with Article 54(1)(a) of the RTS on IRB assessment methodology.

To the extent that the reasons for overriding the outputs of EL BE estimation are relevant also to LGD in-default a consistent override should also be applied to the assignment of LGD in-default in such a way that the add-on to the EL BE covers for any increase of loss rate caused by possible additional unexpected losses during the recovery period in accordance with Article 181(1)(h) of Regulation (EU) No 575/2013.

Irrespective of which of the two approaches referred to in points (a) and (b) of Article 54(1)(a) of the RTS on IRB assessment methodology is used for the purposes of estimating LGD in-default institutions should document separately all of the following:

• (a) the break-down of the LGD in-default into its components: the EL BE and the add-on;
• (b) the break-down of the add-on into all of the following components:
• (i) the downturn conditions component calibrated on the downturn adjustment to the long-run average LGD as specified in paragraph 189;
• (ii) the MoC component, referred to in section 4.4;
• (iii) any component covering for potential additional unexpected losses during the recovery period referred to in Article 181 (1)(h) of Regulation (EU) No 575/2013; this component should only be included in exceptional circumstances where the potential additional losses are not sufficiently reflected in the components referred to in points
• (i) and (ii).