Treatment of incomplete recovery processes

In accordance with Article 181(1)(a) of the CRR, all observed defaults have to be taken into account in the calculation of long-run average LGD; hence, incomplete recovery processes should also be included. These incomplete processes carry valuable information, in particular about the most recent observations, and cases that are particularly difficult and therefore require longer recovery processes. Exclusion of this information would not only lead to loss of relevant, up-to-date information, but could also lead to underestimation of LGD, and this was therefore considered inappropriate.

However, to obtain a realistic value of long-run average LGD, the incomplete recovery processes should be included with future recoveries that are expected to be realised. The value of future recoveries is not an objective, observed measure but has to be estimated based on the recoveries factually observed on those cases that are already closed. As a result, the ‘long-run average LGD’ will also be a measure that is not fully objective, as it contains components that are estimated.

To obtain a fully objective intermediate measure, it is proposed that institutions should also calculate the ‘observed average LGD’ taking into account realised LGDs only on those defaults that are related to closed recovery processes, including those that are treated as closed because they have reached a certain threshold in terms of the time in default, i.e. a maximum length of the recovery process during which additional recoveries can be reasonably expected. Although this objective measure will not include any elements of estimation, it has to be kept in mind that it may not accurately reflect the real experience, as the cure and high-recovery cases may be over-represented. More difficult cases usually stay longer in recovery processes, and therefore they are likely not to be included in the ‘observed average LGD’.

Therefore, the ‘observed average LGD’ has to be adjusted to account for the most recent experience based on the incomplete recovery processes, to obtain an adequate long-run average LGD. For this purpose, institutions should estimate the most likely future recoveries on cases where the processes are not yet complete. As such estimates can be provided only where sufficient data exists to support them, it is proposed that institutions should estimate future recoveries only until a certain point in time, i.e. the maximum length of the recovery process during which a sufficient number of recoveries were actually observed in similar cases. The assumptions underlying the expected future costs and recoveries should be adequately justified and back-tested.

1. Yleiskatsaus

1.1 Viittaukset

1.2 Tunnistetut vaatimukset

1.3 Liittyvät standardit

2. Tunnistetut vaatimukset

3. Liittyvät standardit

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