4.269 The PRA considers that the proposed approach to LGD estimation set out in this section would advance the PRA’s primary objective of safety and soundness. The proposed reduction in the FIRB approach LGD value for unsecured corporate exposures for senior claims (excluding financial institutions) was calibrated by the BCBS based on international empirical data. For example, the PRA considers that the proposed introduction of the LGD alternative methodology under the LGD modelling collateral method should result in more robust LGD estimates, as firms would not be permitted to Bookkeeping for A Law Firm: Best Practices, FAQs Shoeboxed model collateral recoveries when they have limited data to do so effectively. In cases where a firm models risk weights for exposures that would currently qualify for application of the support factor, the modelled risk weights should be risk-sensitive and reflect the firm’s historic experience of lending to that type of exposure. Therefore, the PRA considers that IRB risk weights for exposures qualifying for the infrastructure support factor should reflect the risk, and a further discount on the risk weights is not justified on the basis of the evidence the PRA has available.
4.156 Where non-compliance with modelling standards results in a material understatement of RWAs and/or EL amounts for a particular IRB model, the PRA proposes to require firms to quantify and implement PMAs as an adjustment to RWAs and EL amounts through a PRA Rule. 4.149 The PRA’s rationale for making this proposal is to capture amounts outstanding at default arising from facilities or relationships that are not captured in exposure value measures. Outstanding amounts would not be otherwise captured because either (a) they were not intended to result in credit exposures, or (b) https://intuit-payroll.org/the-founders-guide-to-startup-accounting/ they are not classified as off-balance sheet items. 4.144 The PRA considers that the proposed formulae would continue to help ensure that specific provisions for defaulted exposures cannot be used to cover EL amounts on other exposures. While this is not required by the Basel 3.1 standards, the PRA considers there is sufficient prudential justification for doing so. 4.96 Further detail on the proposed roll-out classes, and the interaction with the proposed exposure classes and sub-classes in the ‘IRB exposure classes and sub-classes’ section, is set out in the table below.
Loss Given Default (LGD)
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- 4.290 The PRA proposes to align with the Basel 3.1 standards and require firms to use a 12-month fixed-horizon approach for EAD modelling.
- While there was a high degree of consistency in firms’ assessments of the relative riskiness of obligors, the analysis identified material dispersion in the levels of estimated risk, as expressed in the probability of default (PD) and loss given default (LGD) that firms assigned to the same exposures.
- 4.262 The PRA has considered whether to retain the wholesale LGD framework in light of the above proposed modelling constraints.
- The PRA notes that the wholesale LGD framework was predominantly targeted at exposures to institutions, financial corporates, and large corporates, as these are typically the most significant low default portfolios.
The timelines would result in all IRB non-modelling changes being implemented by the PRA’s proposed implementation date, which would improve the robustness and risk capture of the IRB approach. In cases where model changes are not made by that date, firms would be required to assess whether PMAs would be appropriate to address any potential undercapitalisation of risk. 4.9 The PRA also proposes changes to improve the operation of the elements of the IRB framework that do not derive from the Basel 3.1 standards. These include a proposal to change the threshold for approving IRB model applications and IRB model changes from ‘full compliance’ with the IRB requirements to ‘material compliance’. The proposed new SS on the IRB approach would incorporate material from the existing SS11/13 as well as from the European Banking Authority’s (EBA) Guidelines related to the IRB framework that the PRA has adopted. The PRA also proposes to make a number of changes to existing expectations to improve the overall consistency and coherence of the PRA’s IRB framework.
Credit risk: The definition of default – PS7/19
As a result, the SA is the only credit risk approach remaining in the Basel 3.1 standards for risk-weighting equity exposures. 4.60 The PRA considers that the proposals to amend the IRB exposure classes and sub-classes are consistent with its primary objective of safety and soundness. The proposed change to the definition of SMEs would likely result in an increase in RWAs for some SME exposures to the extent that the existing definition fails to adequately capture the risk attached to undrawn credit facilities. Where different modelling approaches would be applied to different exposure classes or sub-classes, this is assessed in the relevant section of this CP.
4.270 The proposed removal of the PRA’s LGD wholesale framework reflects the proposed introduction of three new constraints on LGD modelling. The PRA considers that these proposed measures, on balance, would result in an appropriate degree of conservatism. 4.235 This section sets out the PRA’s proposals relating to LGD estimation, including the impact of CRM on LGD models. 4.230 The PRA considers that the Basel 3.1 standards are open to interpretation in respect of the interaction of obligor grade adjustment with CRM techniques, for example PD substitution (which the PRA proposes to retain) and PD adjustment (which the PRA proposes to withdraw).
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This corresponds to a condition already in place in the PRA’s wholesale LGD framework (which the PRA proposes to remove as set out later in this section). The PRA does not propose to set an equivalent expectation for financial collateral, in line with its existing approach. 4.208 The proposed flat 5% LGD floor for retail residential mortgage exposures would be consistent with the floor that the PRA currently expects firms to apply to these exposures. The PRA proposes that this floor would become a requirement in rules as part of these proposals and that the floor would continue to apply regardless of whether the mortgage exposure is UK or non-UK. 4.180 The PRA considers the proposed additional data requirements would not be onerous for firms to implement and therefore considers that these would not have a detrimental impact on the facilitation of effective competition.
