EU definition of default

On 28 September 2016 the European Banking Authority (EBA) published the final Guidelines on the application of the definition of default  across the EU and the final draft Regulatory Technical Standards (RTS) on the materiality threshold of past due credit obligations. Both documents are part of the so-called regulatory review of the Internal Ratings Based (IRB) Approach intended to reduce the variability of IRB models. The documents represent Phase 2 of the regulatory review and are published with a certain delay (they were originally expected by mid-2016). Nevertheless, both the guidelines and the RTS apply to the IRB Approach as well as for the Standardised Approach.

The definition of default of an obligor is specified in Article 178 of the CRR. However, a wide range of practices has been observed across institutions on various aspects of the definition. This substantial variability was confirmed by the quantitative impact study. Therefore, the guidelines provide detailed rules on the application of these aspects of the definition of default, mainly:

 

• the past due criterion including e.g. counting of days past due and technical past due situation, 
• indications of unlikeliness to pay including e.g. sale of credit obligation or distressed restructuring, 
• specific aspects of the application of the definition of default for retail exposures,
• application of the default definition in a banking group, 
• treatment of external data,
• criteria for a return to non-defaulted status including e.g. minimum probation periods and
• documentation and internal policies and processes.

 

The guidelines apply from 1 January 2021 but the competent authorities have the discretion to accelerate the timeline. If the changes are applied as part of internal rating systems they must be verified by the internal validation function and notified or approved by the relevant competent authority.

The RTS specify the conditions for setting the materiality threshold for credit obligations that are past due according to Article 178(6) CRR. The threshold is structured and has an absolute and a relative component. The absolute threshold must be lower than or equal to EUR 100 for retail exposures or EUR 500 for non-retail exposures. It is recommended that the relative threshold should be set at the level of 1% for both retail and non-retail exposures. But in any case the relative threshold must be lower than or equal to 2.5%. Where both of the limits (absolute and relative) are breached for specified number (90 or 180) of consecutive days the obligor default is identified.

The levels of the threshold will be set by competent authorities in a given jurisdiction. It is expected that the implementation of these RTS may have a significant impact on some institutions. In particular, the IRB institutions may be largely affected by the changes of internal processes and data if they will have to change the threshold. The institutions should apply the threshold no later than by 31 December 2020.