6.1 The effects of funded credit protection

Institutions may recognise credit risk mitigation effects of funded credit protection other than master netting agreements and on-balance sheet netting as specified in paragraph 12 for the purposes of Article 181(1)(c)–(g) of Regulation (EU) No 575/2013.

For the purposes of recognising the credit risk mitigation effects of master netting agreements in accordance with Article 166(2) of Regulation (EU) No 575/2013, institutions should use the fully adjusted exposure value (E*) calculated in accordance with Article 220(3) or Article 221(6) of that Regulation as the exposure value when calculating the risk-weighted exposure amounts and expected loss amounts.

For the purposes of recognising the credit risk mitigation effects of on-balance sheet netting in accordance with Article 166(3) of Regulation (EU) No 575/2013, institutions should use E* calculated in accordance with Article 223(5) of that Regulation as the exposure value when calculating the risk-weighted exposure amounts and expected loss amounts.

For the purposes of LGD estimation as referred to in Article 181(1)(a) of Regulation (EU) No 575/2013 and in accordance with paragraph 131 of the EBA GL on PD and LGD estimation, institutions should calculate the realised LGD for each exposure that is covered by a master netting agreement or on-balance sheet netting as the ratio of the economic loss to the outstanding amount of the credit obligation at the moment of default calculated as E* in accordance with paragraph 27 or 28. Institutions should calculate the economic loss on the basis of this outstanding amount, and no cash flows from netting should be included as recoveries after default in the economic loss. Nevertheless, in line with paragraph 131 of the EBA GL on PD and LGD estimation, it is important to recall that the outstanding amount of the credit obligation at the moment of default calculated as E* needs to include any amount of principal, interest or fee realised so far.

For the purposes of recognising the credit risk mitigation effects of collateral in accordance with Article 181(1) of Regulation (EU) No 575/2013, the criteria specified by institutions for adjusting LGD estimates should:

• (a) not lead to a decrease in the value of the LGD estimates when the collateral is a liability of the obligor that ranks either lower than or pari passu with the obligation the obligor has to the institution;
• (b) for other than first rank claims, appropriately consider the effects on LGD estimates of the subordinated position of the institution in relation to the collateral;
• (c) for other physical collateral, appropriately consider the likely location of the collateral during the lifetime of the loan and the influence it may have on the potential inability of institutions to expeditiously gain control of their collateral and liquidate it in accordance with Article 181(1)(e) of Regulation (EU) No 575/2013;