6.3.2.4 Treatment of cases with no loss or positive outcome

Where institutions observe that they realised profit on their observations of defaults, the realised LGD on these observations should equal zero for the purpose of calculation of the observed average LGD and the estimation of the long-run average LGD. Institutions may use the information on the realised LGDs before the application of this floor in the process of model development for the purpose of risk differentiation.

6.3.3 Calibration to the long-run average LGD

Institutions should calibrate their LGD estimates to the long run average LGD calculated in accordance with section 6.3.2. For this purpose institutions should choose a calibration method that is appropriate for their LGD estimation methodology from the following approaches:

• (a) the calibration of LGD estimates to the long-run average LGD calculated for each grade or pool, in which case they should provide additional calibration tests at the level of the relevant calibration segment;
• (b) the calibration of LGD estimates to the long-run average LGD calculated at the level of calibration segment, in particular where they use direct LGD estimates in accordance with Article 169(3) of Regulation (EU) No 575/2013, including where they use LGD estimation methodology based on intermediate parameters. In this case institutions should at least compare this long-run average LGD with the average LGD estimate applied to the same set of observations as those used for calculating the long-run average LGD and, where necessary, correct the individual LGD estimates for the application portfolio accordingly, for instance by using a scaling factor. Where realised values are higher than estimated values at the level of calibration segment, institutions should correct the estimates upwards or readjust their estimation in order to reflect their loss experience.

Where institutions observe extremely high values of realised LGDs much above 100%, especially for exposures with small outstanding amounts at the moment of default, they should identify relevant risk drivers to differentiate these observations and adequately reflect these specific characteristics in the assignment to grades or pool. Where institutions use a continuous rating scale in the LGD estimation, they may create a separate calibration segment for such exposures.

In order to comply with the requirement of Article 181(1)(a) of Regulation (EU) No 575/2013 to use all observed defaults in LGD quantification, institutions should not exclude any defaults observed in the historical observation period that fall within the scope of application of the LGD model.

In the analysis of the representativeness of data in accordance with section 4.2.4, institutions should take into account not only the current characteristics of the portfolio but also, where relevant, the changes to the structure of the portfolio that are expected to happen in the foreseeable future due to specific actions or decisions that have already been taken. Adjustments made on the basis of the changes expected in the foreseeable future should not lead to a decrease in the estimates of LGD parameter.