Commission Delegated Regulation (EU) 2022/439 of 20 October 2021 supplementing Regulation (EU) No 575/2013 of the European Parliament and of the Council with regard to regulatory technical standards for the specification of the assessment methodology competent authorities are to follow when assessing the compliance of credit institutions and investment firms with the requirements to use the Internal Ratings Based Approach (Text with EEA relevance)

(g) in the case of exposures to corporates, institutions, central governments and central banks, and for equity exposures where an institution uses the PD/LGD approach, both, financial and non-financial information is taken into account;

(h) where information necessary for the assignment of exposures to grades or pools is missing or is not up-to-date, the institution has set tolerances for defined metrics and adopted rules in order to take account of that fact in an adequate and conservative way;

(i) financial statements older than 24 months are considered outdated and are treated in a conservative way;

(j) the assignment to grades or pools is part of the credit approval process, in accordance with Article 19;

(k) the criteria for assignment to grades or pools are consistent with the institution’s lending standards and policies for handling troubled obligors and facilities.

(a) there are documented policies setting out the grounds for and the maximum extent of overrides and specifying at what stages of the assignment process the overrides are allowed;

(b) the overrides are sufficiently justified by reference to the grounds set out in the policies referred to in point (a) and that this justification is documented;

(c) the institution regularly carries out an analysis of the performance of exposures the rating of which has been overridden, including an analysis of overrides performed by each member of staff applying the overrides, and that the results of this analysis are taken into account in the decision-making process at an appropriate management level;

(d) the institution collects full information on overrides, including information both before and after the overrides, monitors the number and justifications for overrides on a regular basis, and analyses the effect of overrides on the performance of the model;

(e) the number and justifications for overrides do not indicate significant weaknesses of the rating model.

(a) groups of connected clients as defined in Regulation (EU) No 575/2013 are identified;

(b) information on the ratings and defaults of other relevant entities within the group of connected clients is taken into account in an obligor grade assignment in such a way that the rating grades of each relevant entity in the group reflects the different situation of each relevant entity and its relations with the other relevant entities of the group;

(c) the cases where the obligors are assigned to a better grade than their parent entities are documented and justified.

Article 25

Integrity of assignment process

(a) the staff and management responsible for the final approval of the assignment or of the review of the assignment of exposures to grades or pools are not involved in or responsible for the origination or renewal of exposures;

(b) senior managers of units responsible for the final approval of the assignment or of the review of the assignment of exposures to grades or pools and senior managers of units responsible for the origination or renewal of exposures report to different members of the management body or the relevant designated committee of the institution;

(c) the remuneration of the staff and management responsible for the final approval of the assignment or of the review of the assignment of exposures to grades or pools is not linked to the performance of the tasks relating to the origination or renewal of exposures;

(d) the same practices as those referred to in points (a), (b) and (c) apply to overrides in the retail exposure class.

(a) adequate and detailed policies specify the frequency of the review, and the criteria for the necessity of more frequent reviews having regard to the higher risk of obligors or problematic exposures and that those policies are applied consistently over time;

(b) a review of the assignment is carried out within a maximum of 12 months after the approval of the assignment and that any adjustments to it that are found during the review to be necessary are made within that time-limit;

(c) a review of the assignment is carried out when new material information on the obligor or the exposure becomes available and that any adjustments to it that are found during the review to be necessary are made without undue delay;

(d) the institution has defined criteria and processes for assessing the materiality of new information and the subsequent need for reassignment and that these criteria and processes are applied consistently;

(e) the most recent information available is used in the review of the assignment;

(f) where for practical reasons the assignment has not been reviewed as set out in points (a) to (e), that adequate policies to identify, monitor and remedy the situation are in place and that measures are taken to ensure return to compliance with points (a) to (e);

(g) senior management is regularly informed about the reviews of assignment of exposures to grades or pools and of any delays of the reviews of the assignment referred to in point (f);

(h) there are adequate policies for effectively obtaining and regularly updating relevant information, and that this is reflected appropriately in the terms of the contracts with the obligors.

CHAPTER 6

ASSESSMENT METHODOLOGY FOR IDENTIFICATION OF DEFAULTS

Article 26

General

(a) the detailed specification and practical application of the triggers for identifying the default of an obligor, in accordance with Article 27;

(b) the robustness and effectiveness of the process used by an institution for identifying the default of an obligor, in accordance with Article 28;

(c) the triggers and process used by an institution for the reclassification of a defaulted obligor to non-default status, in accordance with Article 29.

(a) review the institution’s internal criteria, policies and procedures for establishing whether a default has occurred (‘definition of default’) and for the treatment of defaulted exposures;

(b) review the roles and responsibilities of the units and management bodies involved in the identification of the default of an obligor and the management of defaulted exposures;

(c) review the relevant minutes of the institution’s internal bodies, including the management body, or committees;

(d) review the relevant findings of the internal audit or of other control functions of the institution;

(e) review the progress reports on the efforts made by the institution to correct shortcomings and mitigate risks detected during relevant audits;

(f) obtain written statements from or interview the relevant staff and senior management of the institution;

(g) review the criteria used by the personnel responsible for manual assignment of the default status to an obligor or an exposure and of the return to the non-default status.

(a) review the functional documentation of the IT systems used in the process of identification of the default of an obligor;

(b) conduct sample testing and review documents relating to the characteristics of an obligor and to the origination and maintenance of the exposures;

(c) perform their own tests on the data of the institution or require the institution to perform specific tests;

(d) review other relevant documents of the institution.

Article 27

Triggers for identification of the default of an obligor

(a) there is an adequate policy in place with regard to the counting of days past due, including re-ageing of facilities, granting of extensions, amendments or deferrals, renewals and netting of existing accounts;

(b) the definition of default applied by the institution includes at least all of the triggers of default set out in Article 178(1) and (3) of Regulation (EU) No 575/2013;

(c) where an institution uses more than one definition of default within its legal entities, that the scope of application of each definition of default is clearly specified and that the differences between the definitions are justified.

(a) the non-accrued status;

(b) events that constitute specific credit risk adjustments resulting from a significant perceived decline in credit quality;

(c) sales of credit obligations that constitute a material credit-related economic loss;

(d) events that constitute a distressed restructuring;

(e) events that constitute a similar protection to that of bankruptcy;

(f) other indications of unlikeliness to pay.

Article 28

Robustness and effectiveness of the process of identifying the default of an obligor

(a) there are adequate procedures and mechanisms in place to ensure that all defaults are identified in a timely manner, in particular that the gathering and updating of relevant information are effective and take place with sufficient frequency;

(b) where the identification of default of an obligor is based on automatic processes, tests are carried out to verify that defaults are correctly identified by the IT system;

(c) for the purposes of identifying the default of an obligor based on human judgement, the criteria for the assessment of the obligors and triggers of default are set out in sufficient detail in the internal documentation to ensure consistency in the identification of defaults by all members of the staff involved in such identification;

(d) where the institution applies the definition of default at the obligor level, there are adequate procedures and mechanisms in place to ensure that once default is identified for an obligor, all exposures to that obligor are registered as being in default in all relevant systems, business lines and geographical locations within the institution and its subsidiaries, and where applicable, within its parent undertaking, and its subsidiaries;

(e) where the assignment of the default status to all exposures to an obligor as referred to in point (d) is delayed following the default of one or several exposures of the obligor, that delay does not lead to errors or inconsistencies in risk management, risk reporting, the calculation of own funds requirements or the use of data in risk quantification.

(a) there are adequate procedures and mechanisms in place to ensure that the default status is assigned in accordance with Article 178(1)(b) of Regulation (EU) No 575/2013 on the basis of the assessment set out in Article 178(2)(d) of that Regulation and compliant with the materiality threshold relevant to a credit obligation past due as defined by the competent authorities in accordance with Delegated Regulation (EU) 2018/171;

(b) the process of counting days past due is consistent with the contractual or legal obligations of the obligor, reflects adequately partial payments and is applied consistently.

(a) the institution has a clear policy with regard to the application of the default definition for retail exposures either at the level of the obligor or at the level of the individual credit facility;

(b) the policy referred to in point (a) is aligned with the institution’s risk management and is applied consistently;

Article 29

Reclassification to non-default status

(a) the triggers for reclassification are determined for each trigger of default and that the identification and treatment of credit obligations subject to distressed restructuring are clearly specified;

(b) reclassification is possible only after all triggers of default have ceased to apply and all relevant conditions for reclassification are met;

(c) the triggers and process of reclassification are determined in a prudent way, in particular that they ensure that reclassification to a non-default status is not performed where the institution expects the credit obligation not to be paid in full without recourse by the institution to actions such as realising security.

CHAPTER 7

ASSESSMENT METHODOLOGY FOR RATING SYSTEMS DESIGN, OPERATIONAL DETAILS AND DOCUMENTATION

SECTION 1

General

Article 30

General

(a) the adequacy of the documentation on the rationale, design, and operational details of the rating systems, as set out in Article 175 of Regulation (EU) No 575/2013, in accordance with Articles 31 and 32;

(b) the adequacy of the structure of the rating systems, as referred to in Article 170 of Regulation (EU) No 575/2013, in accordance with Articles 33 to 36;

(c) the application by the institution of the specific requirements for statistical models or other mechanical methods, as referred to in Article 174 of Regulation (EU) No 575/2013, in accordance with Articles 37 to 40.

(a) review the institution’s relevant internal policies;

(b) review the institution’s technical documentation on the methodology and the process of the rating systems development;

(c) review the development manuals, methodologies and processes on which the rating systems are based;

(d) review the minutes of the institution’s internal bodies responsible for approving the rating systems, including the management body or committees designated by it;

(e) review the reports on the performance of the rating systems and the recommendations of the credit risk control unit, validation function, internal audit function or any other control function of the institution;

(f) review the progress reports on the efforts made by the institution to correct shortcomings and mitigate risks detected during monitoring, validations and relevant audits;

(g) obtain written statements from or interview the relevant staff and senior management of the institution.

(a) request and analyse data used in the process of developing the rating systems;

(b) conduct their own estimations or replicate those of the institution performed during the development and monitoring of the rating systems using relevant data supplied by the institution;

(c) request additional documentation from the institution or request that it provides analysis related to the choice of methodology for designing the rating system and provides information about the results obtained;

(d) review the functional documentation of the IT systems relevant to the scope of the assessment of the rating systems design, operational details and documentation;

(e) perform the competent authority’s own tests on the data of the institution or request the institution to perform tests proposed by the competent authority;

(f) review other relevant documents of the institution.

SECTION 2

Methodology for assessing the documentation on the rationale, design and operational details of rating systems

Article 31

Completeness of the documentation of rating systems

(a) the adequacy of the rating system and the models used within the rating system taking into account the portfolio characteristics;

(b) a description of data sources and data cleansing practices;

(c) definitions of default and loss;

(d) methodological choices;

(e) technical specification of the models;

(f) the weaknesses and limitations of the models and possible mitigating factors thereof;

(g) the results of the implementation tests of the models in the IT systems, in particular information on whether the implementation was successful and error-free;

(h) a self-assessment of compliance with regulatory requirements for the Internal Ratings Based Approach as referred to in Articles 169 to 191 of Regulation (EU) No 575/2013.

(a) the documentation clearly outlines the purpose of the rating system and the models;

(b) the documentation includes a description of the range of application of the rating system and the scope of application of the models used within the rating system, i.e. a specification of the type of exposures covered by each model within the rating system, both in a qualitative and in a quantitative manner, the type of outputs of each model and the use made of the outputs;

(c) the documentation includes an explanation about how the information obtained by means of the rating system and the results of the models is taken into account for the purposes of risk management, decision-making and credit approval processes, as referred to in Article 19.

(a) detailed information regarding all data used for the model development, including a precise definition of the content of the model, its source, format and coding and, where applicable, exclusions of data from it;

(b) any data cleansing procedures including procedures for data exclusions, outlier detection and treatment and data adaptations, as well as an explicit justification for their use and an evaluation of their impact.

(a) details on the design, theory, assumptions, and logic underlying the model;

(b) detailed descriptions of the model methodologies and their rationale, statistical techniques and approximations and, where appropriate, the rationale and details on segmentation methods, the outputs of statistical processes and the diagnostics and measures of predictive power of the models;

(c) the role of experts from the relevant business areas in developing the rating system and models, including a detailed description of the consultation process with experts from the relevant business areas in the design of the rating system and models as well as outputs and rationale provided by those experts from the relevant business areas;

(d) an explanation of how the statistical model and human judgement are combined to derive the final model output;

(e) an explanation of how the institution takes into account unsatisfactory quality of data, lack of homogeneous pools of exposures, changes in business processes, economic or legal environment and other factors relating to quality of data that may affect the performance of the rating system or model;

(a) the technical specification of the final model structure including final model specifications, input components including type and format of selected variables, weights applied for variables and output components including type and format of output data;

(b) references to the computer codes and tools used in terms of IT languages and programs allowing a third party to reproduce the final results.

For the purposes of point (b), the third party may be the vendor in the case of vendor models.

(a) the documentation specifies the process to be followed when a new or changed model is implemented in the production environment;

(b) the documentation covers the results of the tests of the implementation of the rating models in the IT systems, including the confirmation that the rating model implemented in the production system is the same as the one described in the documentation and is operating as intended.

Article 32

Register of rating systems

(a) the range of application of the rating system, specifying which type of exposures is to be rated by each rating model;

(b) the management responsible for the approval and date of internal approval, the date of notifying to the competent authorities, the date of the approval by the competent authorities, where applicable, and the date of implementation of the version;

(c) a brief description of any changes relative to the previous version that has been considered in the register, including a description of the aspects of the rating system which have been changed and a reference to the model documentation;

(d) the change category assigned in accordance with Delegated Regulation (EU) No 529/2014 and a reference to the criteria for assignment to a change category.

SECTION 3

Methodology for assessing the structure of rating systems

Article 33

Risk drivers and rating criteria

(a) the selection process of the relevant risk drivers and rating criteria, including the definition of potential risk drivers, criteria for selection of risk drivers and decisions taken on the relevant risk drivers;

(b) the consistency of the selected risk drivers and rating criteria and their contribution to the risk assessment with the expectations of the business users of the rating system;

(c) the consistency of the risk drivers and rating criteria selected on the basis of statistical methods with the statistical evidence on risk differentiation associated with each grade or pool.

(b) transaction risk characteristics, including type of product, type of collateral, seniority, loan-to-value ratio;

(c) information on delinquency: internal information or information derived from external sources, such as credit bureaus.

Article 34

Distribution of obligors and exposures in the grades or pools

(b) the concentration of numbers of exposures or obligors is not excessive in any grade or pool, unless such distribution is supported by convincing empirical evidence of homogeneity of risk of those exposures or obligors;

(c) the rating and facility grades or pools for retail exposures have a sufficient number of exposures or obligors in a single grade or pool, unless such distribution is supported by convincing empirical evidence that the grouping of those exposures or obligors is adequate, or that direct estimates of risk parameters for individual obligors or exposures are used as referred to in Article 169(3) of Regulation (EU) No 575/2013;

(d) the rating and facility grades or pools for exposures to corporates, institutions, central governments and central banks, where sufficient data is available, do not have too few exposures or obligors in a single grade or pool, unless the distribution of exposures or obligors is supported by convincing empirical evidence that the grouping of those exposures or obligors is adequate, or that direct estimates of risk parameters for individual obligors or exposures are used as referred to in Article 169(3) of Regulation (EU) No 575/2013.

(a) the maximum and the minimum overall number of grades or pools;

(b) the proportion of exposures and obligors assigned to each grade or pool.

Article 35

Risk differentiation

(a) that the tools used to assess risk differentiation are sound and adequate considering the available data and that the adequate risk differentiation is evidenced with records of time series of realised default rates or loss rates for grades or pools under various economic conditions;

(b) that the expected performance of the rating system as regards risk differentiation is defined by the institution by means of clearly established fixed targets and tolerances for defined metrics and tools as well as actions to rectify deviations from these targets or tolerances; separate targets and tolerances may be defined for the initial development and the ongoing performance;

(c) that the targets and tolerances for defined metrics and tools and mechanisms applied to meet those targets and tolerances ensure sufficient differentiation of risk.

Article 36

Homogeneity

(a) internal ratings;

(b) estimates of PD;

(c) where applicable, own estimates of LGD;

(d) where applicable, own estimates of conversion factors;

(e) where applicable, own estimates of total losses. For retail exposures competent authorities shall assess those factors for each rating system. For exposures other than retail exposures competent authorities shall assess them only for those rating systems in respect of which a sufficient quantity of data is available.

SECTION 4

Methodology for assessing specific requirements for statistical models or other mechanical methods

Article 37

Data requirements

(a) the reliability and quality of the internal and external data sources and the range of data obtained from those sources, as well as the time period the sources cover;

(b) the process of data merging, where the model is fed with data from multiple data sources;

(c) the rationale and scale of data exclusions broken down by reason for exclusion, using statistics on the share of total data which each exclusion covers where certain data were excluded from the model development sample;

(d) the procedures for dealing with erroneous and missing data and treatment of outliers and categorical data, and verify that, where there has been a change in the type of categorisation, this does not lead to decreased data quality or structural breaks in the data;

(e) the processes for data transformation, including standardization and other functional transformations, and the appropriateness of those transformations having regard to the risk of model overfitting.

(a) the comparability of risk characteristics of the obligors or facilities reflected in the data used to build the model with those of the exposures covered by a particular rating model;

(b) the comparability of the current underwriting and recovery standards with the ones applied at the time to which the reference data set used for the modelling relates;

(d) where external data or data pooled across institutions is used in the model development, the relevance and adequacy of such data for the institution’s exposures, products and risk profile.

Article 38

Model design

When assessing the rating model design for the purposes of Article 174(a) of Regulation (EU) No 575/2013, competent authorities shall verify:

(a) the adequacy of the model having regard to its specific application;

(b) the institution’s analysis of alternative assumptions or alternative approaches to those chosen in the model;

(c) the institution’s methodology for model development;

Article 39

Human judgement

When assessing whether the statistical model or another mechanical method is complemented by human judgement in accordance with Article 174(e) of Regulation (EU) No 575/2013 and whether human judgement is applied in a proportionate and adequate manner in the development of the rating model and in the process of assigning exposures to grades or pools, competent authorities shall verify that:

(a) the manner in which human judgement is applied is justified and fully documented and that the impact of human judgement on the rating system is assessed, if possible also by means of a computation of the marginal contribution of human judgement to the performance of the rating system;

(b) all relevant information not considered in the model is taken into account and an adequate level of conservatism is applied;

(d) the application of human judgement is appropriately managed and proportionate to the type of exposures for each rating system.

Article 40

Model performance

When assessing the predictive power of the model required under Article 174(a) of Regulation (EU) No 575/2013, competent authorities shall verify that the institution’s internal standards:

(a) provide an outline of the assumptions and theory underlying the metrics chosen by the institution for the purpose of the assessment of the model’s performance;

(b) specify the application of the metrics, indicate whether the use of each metric is compulsory or discretionary and when it is to be used and ensure that the metrics are used coherently;

(c) specify the conditions of the applicability and acceptable thresholds and accepted deviations for the metrics and set out whether and, if so, how statistical errors relating to the values of those metrics are taken into account in the assessment process, and, where more than one metric is calculated, establishes the methods of aggregating several test results to one single assessment;

(d) determine a process for ensuring that events of model performance deterioration leading to the breach of the thresholds referred to in point (c) are communicated to the appropriate members of the senior management in charge of it and that clear guidance on how the outcomes of the metrics are considered is provided by the members of the management responsible for taking final decision as regards implementation of the necessary changes to the model.

CHAPTER 8

ASSESSMENT METHODOLOGY FOR RISK QUANTIFICATION

SECTION 1

General

Article 41

General

(a) compliance with the overall requirements for estimation laid down in Article 179 of Regulation (EU) No 575/2013, in accordance with Articles 42, 43 and 44;

(b) compliance with the requirements specific to PD estimation laid down in Article 180 of Regulation (EU) No 575/2013, in accordance with Articles 45 and 46;

(c) compliance with the requirements specific to own-LGD estimates laid down in Article 181 of Regulation (EU) No 575/2013, in accordance with Articles 47 to 52;

(d) compliance with the requirements specific to own-conversion factor estimates laid down in Article 182 of Regulation (EU) No 575/2013, in accordance with Articles 53 to 56;

(e) compliance with the requirements for assessing the effect of guarantees and credit derivatives laid down in Article 183 of Regulation (EU) No 575/2013, in accordance with Article 57;

(f) compliance with the requirements for purchased receivables laid down in Article 184 of Regulation (EU) No 575/2013, in accordance with Article 58.

(a) review the institution’s relevant internal policies;

(b) review the institution's technical documentation of relevant estimation methodology and process;

(c) review and challenge the relevant estimation of risk parameter manuals, methodologies and processes;

(d) review the relevant minutes of the institution’s internal bodies, including the management body, model committee, or other committees;

(e) review the reports on the performance of risk parameters and the recommendations made by the credit risk control unit, the validation function, the internal audit function or any other control function of the institution;

(f) assess progress reports on the efforts made by the institution to correct shortcomings and mitigate risks detected during relevant audits, validations and monitoring;

(g) obtain written statements from or interview the relevant staff and the senior management of the institution.

(a) request the provision of additional documentation or analysis substantiating the institution’s methodological choices and the results obtained;

(b) conduct their own estimations of risk parameters or replicate those of the institution, using the relevant data supplied by the institution;

(c) request and analyse the data used in the process of estimation;

(d) review the functional documentation of the IT systems which are relevant to the scope of the assessment;

(e) perform their own tests on the data of the institution or request the institution to perform tests proposed by the competent authorities;

(f) review other relevant documents of the institution.

SECTION 2

Methodology for assessing overall requirements for quantification of risk parameters

Article 42

Data requirements

(a) the completeness of the quantitative and qualitative data and other information in relation to the methods used for the quantification of risk parameters to ensure that all relevant historical experience and empirical evidence are used;

(b) the availability of quantitative data providing a breakdown of the loss experience by the factors which drive the respective risk parameters as referred to in Article 179(1)(b) of Regulation (EU) No 575/2013;

(c) the representativeness of the data used to estimate the risk parameters for certain types of exposures;

(d) the adequacy of the number of exposures in the sample and the length of the historical observation period referred to in Articles 45, 47 and 53, used for the quantification to ensure that the estimates of the institution are accurate and robust;

(e) the justification for and the documentation of all data cleansing, including any exclusions of observations from the estimation and a confirmation that these exclusions do not bias the risk quantification; for PD estimates, in particular, the justification and the documentation of the impact of the data cleansing on the long-run average default rate;

(f) the consistency between the data sets used for the risk parameters estimation, in particular with regard to the default definition, treatment of defaults, including multiple defaults as referred to in Articles 46(1)(b) and 49, and the sample composition.

(a) the structure of exposures covered by each rating model and the different risk characteristics of the obligors or facilities, and whether the current portfolio is, to the degree required, comparable to the portfolios constituting the reference data set;

(b) the comparability of the current underwriting and recovery standards with the ones applied at the time of the reference data set;

(d) where external data and data pooled across institutions are used in the quantification of risk parameters, the relevance and appropriateness of these data for the institution’s exposures, products and risk profile and the definition of default;

(e) where the external or pooled data are not consistent with the institution’s internal default definition, the description of adjustments to the external or pooled data performed by the institution in order to achieve the required level of consistency with the internal default definition.

Article 43

Review of estimates

When assessing the review of risk parameter estimates by the institution as referred to in Article 179(1)(c) of Regulation (EU) No 575/2013, competent authorities shall verify that:

(a) the process and the annual plan for the review of estimates provide for a timely review of all estimates;

(b) criteria for the identification of situations which trigger a more frequent review have been identified;

(c) the methodologies and data used for the estimation of risk parameters reflect changes in the underwriting process and in the composition of the portfolios;

(d) the methodologies and data used for the LGD estimation reflect changes in the recovery process, the types of recoveries and the duration of the recovery process;

(e) the methodologies and data used for the conversion factor estimation reflect changes in the monitoring process of undrawn amounts;

(f) the data set used for the estimation of risk parameters includes the relevant data from the latest observation period, and are updated at least on an annual basis;

(g) the technical advances and other relevant information are reflected in the risk parameters estimates.

Article 44

Margin of conservatism

(a) the methods and data do not provide sufficient certainty of the risk parameter estimates, including where there are high estimation errors;

(b) relevant deficiencies in the methods, information and data have been identified by the credit risk control unit, validation function or internal audit function or any other function of the institution;

(c) relevant changes to the standards of underwriting or recovery policies or changes in the institution’s risk appetite.

SECTION 3

Methodology for assessing requirements specific for PD estimation

Article 45

Length of the historical observation period

When assessing the length of the historical observation period referred to in point (h) of Article 180(1) and point (e) of Article 180(2) of Regulation (EU) No 575/2013, taking into account conditions laid down in Commission Delegated Regulation (EU) 2017/72 with regard to regulatory technical standards specifying conditions for data waiver permissions (6), and the calculation of one year default rates based on internal default experience as referred to in point (e) of Article 180(1), competent authorities shall verify:

(a) that the length of the historical observation period covers at least the minimum length in accordance with the requirements laid down in point (h) of paragraph 1 and point (e) of paragraph 2 of Article 180 of Regulation (EU) No 575/2013 and, where applicable, Delegated Regulation (EU) 2017/72;

(b) where the available historical observation period is longer than the minimum period required in point (h) of Article 180(1) or in point (e) of Article 180(2) of Regulation (EU) No 575/2013 for a data source, and the data obtained from it are relevant, that the information for that longer period is used in order to estimate the long-run average of one-year default rates;

(c) for retail exposures where the institution does not give equal importance to all historical data used, that this is justified by better prediction of default rates and that a zero or very small weight applied to a specific period is either duly justified or leads to more conservative estimates;

(d) that there is consistency between underwriting standards and the rating systems in place and that comparable underwriting standards were used at the time of generating the internal default data or that changes in underwriting standards and rating systems have been addressed by applying the margin of conservatism as referred to in point (c) of Article 44(1);

(e) for exposures to corporates, institutions, central governments and central banks, that the definition of obligors that are highly leveraged and obligors whose assets are predominantly traded assets as referred to in point (a) of Article 180(1) of Regulation (EU) No 575/2013 as well as the identification of periods of stressed volatilities for those obligors as referred to in that provision are adequate.

Article 46

Method of PD estimation

(a) the denominator of the one-year default rate includes the obligors or exposures which, at the beginning of a one year period, are not in default and are assigned to that rating grade or pool;

(b) the numerator of the one-year default rate includes those of the obligors or exposures referred to in point (a) that have defaulted within that one year period; multiple defaults for the same obligor or exposure, which have been observed during the one year period relating to the default rate, are considered to be a single default as referred to in Article 49(b) having occurred on the date of the first of those multiple defaults.

For that purpose they shall verify that the period used by the institution to estimate the long-run average of one-year default rates is representative of the likely range of variability of default rates for that type of exposures.

(a) the institution uses an appropriate alternative method for estimating the average of one-year default rates over a period that is representative of the likely range of variability of default rates for that type of exposures;

(b) an appropriate margin of conservatism is applied where, after applying an appropriate method as referred to in point (a), the estimation of the averages of default rates is found to be unreliable or to have other limitations.

(a) the functional and structural form of the estimation method;

(b) assumptions on which the estimation method is based;

(c) the cyclicality of the estimation method;

(d) the length of the historical observation period used in accordance with Article 45;

(e) the margin of conservatism applied in accordance with Article 44;

(f) the human judgement;

(g) where applicable, the choice of risk drivers.

SECTION 4

Methodology for assessing requirements specific to own-LGD estimates

Article 47

Length of the historical observation period

When assessing the length of the period used for LGD estimation for the purpose of point (j) of paragraph 1 and subparagraph 2 of paragraph 2 of Article 181 of Regulation (EU) No 575/2013 and Delegated Regulation (EU) 2017/72, (‘historical observation period’), competent authorities shall verify that:

(a) the length of the historical observation period covers at least the minimum length in accordance with the requirements laid down in paragraph 1(j) and the second subparagraph of paragraph 2 of Article 181 of Regulation (EU) No 575/2013 and, where applicable, Delegated Regulation (EU) 2017/72;

(b) where the available historical observation period is longer than the minimum period according to point (j) of paragraph 1 of Article 181 and subparagraph 2 of paragraph 2 of Article 181 of Regulation (EU) No 575/2013 for a data source, and the data obtained from it are relevant for the LGD estimation, that the information for that longer period is used;

(c) for retail exposures, where the institution does not give equal importance to all historical data used, that this is justified by better prediction of loss rates and that a zero or very small weight applied to a specific period is either duly justified or leads to more conservative estimates.

Article 48

Method of LGD estimation

When assessing the method of own-LGD estimation, as referred to in Article 181 of Regulation (EU) No 575/2013, competent authorities shall verify that:

(a) the institution assesses LGD by homogenous facility grade or pool;

(b) the average realized LGD by facility grade or pool is calculated using the number of default weighted average;

(c) all observed defaults within the data sources are used, in particular that the incomplete recovery processes are taken into account in a conservative manner for the purposes of LGD estimation, and that the choice of workout period and methodologies for estimating additional costs and recoveries after and, where necessary, during that period, are relevant;

(d) the LGD estimates of secured exposures are not solely based on the estimated market value of the collateral and that they take into account the realised revenues from past liquidations and the potential inability of an institution to gain control of the collateral and liquidate it;

(e) the LGD estimates of secured exposures take into account the potential decreases in collateral value from the point of time of LGD estimation to the eventual recovery;

(f) the degree of dependence between the risk of the obligor and that of the collateral as well as the cost of liquidating the collateral are taken into account conservatively;

(g) any unpaid late fees that have been capitalised in the institution’s income statement before the default are added to the institution’s measure of exposure and loss;

(h) the possibility of future drawings after the default is taken into account appropriately;

Article 49

Treatment of multiple defaults

For the treatment of obligors that default and recover several times in a limited period of time as defined by the institution (‘multiple defaults’), competent authorities shall assess the adequacy of the methods used by the institution and shall verify that:

(a) explicit conditions are defined before a facility is considered to have returned to a non-default status;

(b) multiple defaults identified within a period of time specified by the institution are considered to be a single default for the purpose of LGD estimation, using the default date of the first observed default as the relevant default date and considering the recovery process from that date until the end of the recovery process after the last observed default in this period;

(c) the length of period within which multiple defaults are recognised as a single default is determined taking into account the institution’s internal policies and analysis of the default experience;

(d) defaults used for the purpose of PD and conversion factors estimation are treated consistently with defaults used for the purpose of LGD estimation.

Article 50

Use of LGD estimates appropriate for economic downturn

When assessing whether the requirement to use LGD estimates that are appropriate for an economic downturn as laid down in point (b) of Article 181(1) of Regulation (EU) No 575/2013 is fulfilled, competent authorities shall verify that:

(a) the institution uses LGD estimates that are appropriate for an economic downturn, where those are more conservative than the long-run average;

(b) the institution provides both long-run averages and LGD estimates appropriate for an economic downturn for justification of its choices;

(c) the institution applies a rigorous and well documented process for identifying an economic downturn and assessing its effects on recovery rates and for producing LGD estimates appropriate for an economic downturn;

(d) the institution incorporates in the LGD estimates any adverse dependencies that have been identified between on the one hand selected economic indicators and on the other hand the recovery rates.

Article 51

LGD, ELBE and UL estimation for exposures in-default

’) as referred to in Article 181(1)(h) of Regulation (EU) No 575/2013, competent authorities shall verify that the institution uses one of the following approaches and shall assess the approach used by the institution:

(a) direct estimation of the LGD for defaulted exposures (‘LGD in-default’) and direct estimation of ELBE;

(b) direct estimation of ELBE and estimation of the LGD in-default as the sum of ELBE and an add-on capturing the unexpected loss related to exposures in default that might occur during the recovery period.

(a) the LGD in-default estimation methods, either as a direct estimation or as an add-on to ELBE, take into account possible additional unexpected losses during the recovery period, and in particular consider possible adverse changes in economic conditions during the expected length of the recovery process;

(b) the LGD in-default, either as a direct estimation or as an add-on to ELBE, and the ELBE estimation methods take into account the information on the time in- default and recoveries realised so far;

(c) where the institution uses a direct estimation of the LGD in-default, the estimation methods are consistent with the requirements of Articles 47, 48 and 49;

(d) the LGD in-default estimate is higher than the ELBE, or, where the LGD in- default is equal to the ELBE, that for individual exposures such cases are limited and duly justified by the institution;

(e) the ELBE estimation methods take into account all currently available and relevant information and in particular consider current economic circumstances;

(f) where the specific credit risk adjustments exceed the ELBE estimates the differences between the two are analysed and duly justified;

(g) the LGD in-default, either as a direct estimation or as an add-on to ELBE, and the ELBE estimation methods are clearly documented.

Article 52

Requirements on collateral management, legal certainty and risk management

When assessing whether the institution has established internal requirements for collateral management, legal certainty and risk management which are generally consistent with those set out in Chapter 4, Section 3 of Regulation (EU) No 575/2013, as referred to in Article 181(1)(f) of that Regulation, competent authorities shall verify that at least the policies and procedures of the institution relating to the internal requirements for collateral valuation and legal certainty are fully consistent with the requirements of Section 3 of Chapter 4 of Title II in Part Three of Regulation (EU) No 575/2013.

SECTION 5

Methodology for assessing requirements specific to own- conversion factor estimates

Article 53

Length of the historical observation period

When assessing the length of the period used for the estimation of conversion factors referred to in paragraph 2 and paragraph 3 of Article 182 of Regulation (EU) No 575/2013 and Delegated Regulation (EU) 2017/72 (‘historical observation period’), competent authorities shall verify that:

(a) the length of the historical observation period covers at least the minimum length required by paragraph 2 and paragraph 3 of Article 182 of Regulation (EU) No 575/2013 and, where applicable, Delegated Regulation (EU) 2017/72;

(b) where the available observation period is longer than the minimum period required by paragraph 2 and paragraph 3 of Article 182 of Regulation (EU) No 575/2013 for a data source, and the data obtained from it are relevant for the estimation of conversion factors, that the information for that longer period is used;

(c) for retail exposures, where the institution does not give equal importance to all historical data used, that this is justified by better prediction of drawings on commitments and that, if a zero weight or a very small weight is applied to a specific period, this is either duly justified or leads to more conservative estimates.

Article 54

Method of conversion factors estimation

When assessing the method of estimating conversion factors as referred to in Article 182 of the Regulation (EU) No 575/2013, competent authorities shall verify that:

(a) the institution assesses estimates of conversion factors by facility grade or pool;

(b) the average realised conversion factors by facility grade or pool are calculated using the number of default weighted average;

(c) all observed defaults within the data sources are used for conversion factors estimation;

(d) the possibility of additional drawings is taken into account in a conservative manner, except for retail exposures when they are included in the LGD estimates;

(e) the institution’s policies and strategies regarding account monitoring, including limit monitoring, and payment processing are reflected in the conversion factors estimation;

Article 55

Use of conversion factor estimates appropriate for economic downturn

When assessing whether the requirement to use conversion factor estimates that are appropriate for an economic downturn as laid down in point (b) of Article 182(1) of Regulation (EU) No 575/2013 is fulfilled, competent authorities shall verify that:

(a) the institution uses conversion factor estimates that are appropriate for an economic downturn, where those are more conservative than the long-run average;

(b) the institution provides both the long-run averages and the conversion factor estimates appropriate for an economic downturn for justification of its choices;

(c) the institution applies a rigorous and well documented process for identifying an economic downturn and assessing its effects on the drawing of credit limits and for producing conversion factor estimates appropriate for an economic downturn;

(d) the institution incorporates in the conversion factor estimates any adverse dependencies that have been identified between on the one hand the selected economic indicators and on the other hand the drawing of credit limits.

Article 56

Requirements on policies and strategies for account monitoring and payment processing

In order to assess compliance with the requirements regarding the estimation of the conversion factors as referred to in point (d) and (e) of Article 182(1) of Regulation (EU) No 575/2013, competent authorities shall verify that the institution has policies and strategies in place in respect of account monitoring and payment processing, and has adequate systems and procedures to monitor facility amounts on a daily basis.

SECTION 6

Methodology for assessing the effect of guarantees and credit derivatives

Article 57

Eligibility of guarantors and guarantees

When assessing compliance with the requirements for assessing the effect of guarantees and credit derivatives on risk parameters as referred to in Article 183 of Regulation (EU) No 575/2013, competent authorities shall verify that:

(a) the institution has clearly specified criteria for identifying situations where PD estimates or LGD estimates are to be adjusted in order to incorporate mitigating effects of guarantees, and that those criteria are used consistently over time;

(b) where the PD of the protection provider is to be used for the purpose of adjusting the risk-weighted exposure amounts in accordance with Article 153(3) of Regulation (EU) No 575/2013, the mitigating effects of guarantees are not included in the estimates of LGD or PD of the obligor;

(c) the institution has clearly specified criteria for recognising guarantors and guarantees for the calculation of risk-weighted exposure amounts, in particular through own estimates of LGD or PD;

(d) the institution documents the criteria for adjusting own estimates of LGD or PD to reflect the effects of guarantees;

(f) the institution meets the requirements of points (a) and (e) also for the single-name credit derivatives.

SECTION 7

Methodology for assessing the requirements for purchased receivables

Article 58

Risk parameter estimates for purchased corporate receivables

(a) EL is estimated from the long-run average of one-year total loss rates or by another appropriate approach;

(b) the process for estimating the total loss is consistent with the concept of LGD as set out in Article 181(1)(a) of Regulation (EU) No 575/2013;

(c) that the institution is able to decompose its EL estimates into PDs and LGDs in a reliable way;

(d) in the case of purchased corporate receivables where Article 153(6) of Regulation (EU) No 575/2013 is applied, sufficient external and internal data are used.

(a) assess those estimates in accordance with Articles 42 to 52;

(b) verify that the requirements of Article 184 of Regulation (EU) No 575/2013 are met.

CHAPTER 9

ASSESSMENT METHODOLOGY FOR ASSIGNMENT OF EXPOSURES TO EXPOSURE CLASSES

Article 59

General

(a) the institution’s assignment methodology and its implementation, in accordance with Article 60;

(b) the assignment sequence of the exposures to exposure classes, in accordance with Article 61;

(c) whether specific considerations with regard to the retail exposure class have been taken into account by the institution, in accordance with Article 62.

(a) review the institution’s relevant internal policies, procedures and assignment methodology;

(b) review the relevant minutes of the institution’s internal bodies, including the management body, or committees;

(c) review the relevant findings of the internal audit or of other control functions of the institution;

(d) review the progress reports on the efforts made by the institution to correct shortcomings and mitigate risks detected during relevant audits;

(e) obtain written statements from or interview the relevant staff and senior management of the institution;

(f) review the criteria used by the personnel responsible for the manual assignment of exposures to exposure classes.

(a) conduct sample testing and review documents related to the characteristics of an obligor and to the origination and maintenance of the exposures;

(b) review the functional documentation of the relevant IT systems;

(c) compare the institution’s data with data publicly available, including data recorded in the database maintained by EBA in accordance with Article 115(2) of Regulation (EU) No 575/2013 or in the databases maintained by the competent authorities;

(d) verify the institution’s compliance with the Commission Implementing Decision 2014/908/EU (7) on the equivalence of the supervisory and regulatory requirements of certain third countries and territories for the purposes of the treatment of exposures according to Regulation (EU) No 575/2013;

(e) perform own tests on the data of the institution or request the institution to perform tests proposed by the competent authorities;

(f) review other relevant documents of the institution.

Article 60

Assignment methodology and its implementation

(a) the methodology is fully documented and complies with all requirements laid down in Article 147 of Regulation (EU) No 575/2013;

(b) the methodology reflects the assigning sequence laid down in Article 61;

(c) the methodology includes a list of the regulatory and supervisory regimes of third countries considered equivalent to those applied in the Union in accordance with the Implementing Decision 2014/908/EU as referred to in Article 107(4), Article 114(7), Article 115(4) and Article 116(5) of Regulation (EU) No 575/2013, when such an equivalence is required for the assignment of an exposure to a specific class.

(a) the procedures governing the input and transformations of data in the IT systems are sufficiently robust to ensure correct assignment of each exposure to an exposure class;

(b) sufficiently detailed criteria are available for the personnel responsible for the assignment of the exposures to ensure a consistent assignment;

(c) the assignment to equity exposures, items representing securitisation positions and exposures identified as specialised lending exposures in accordance with Article 147(8) of Regulation (EU) No 575/2013 is performed by personnel who are aware of the terms and conditions and of the relevant details of the transaction that determine the identification of those exposures;

(d) the assignment is performed using the most recent data available.

Article 61

Assigning sequence

When assessing whether the institution assigns exposures to exposure classes in compliance with Article 147 of Regulation (EU) No 575/2013, the competent authorities shall verify that the assignment is carried out in the following sequence:

(a) first, exposures eligible to be classified under equity exposures, items representing securitisation positions and other non-credit obligation assets are assigned to those classes in accordance with points (e), (f) and (g) of Article 147(2) of Regulation (EU) No 575/2013;

(b) second, exposures which have not been assigned in accordance with point (a) and which are eligible to be classified under the classes for exposures to central governments and central banks, exposures to institutions, exposures to corporates or retail exposures are assigned to those classes in accordance with points (a), (b), (c) and (d) of Article 147(2) of Regulation (EU) No 575/2013;

(c) third, any credit obligations not assigned in accordance with point (a) or (b) are assigned to the class of exposures to corporates in accordance with Article 147(7) of Regulation (EU) No 575/2013.

Article 62

Specific requirements for retail exposures

(a) the institution distinguishes between exposures to natural persons and to SMEs based on clear criteria in a consistent manner;

(a) marketing and sales activities;

(b) type of product;

(c) rating process;

(d) rating system;

(e) credit decision process;

(f) credit risk mitigation methods;

(g) monitoring processes;

(h) collection and recovery process.

(b) for the purposes of verifying compliance with Article 154(3) of Regulation (EU) No 575/2013, competent authorities shall verify that for all exposures where the immovable property collateral is used in the own-LGD estimates in accordance with Article 181(1)(f) of Regulation (EU) No 575/2013, the coefficient of correlation laid down in Article 154(3) of Regulation (EU) No 575/2013 is assigned.

CHAPTER 10

ASSESSMENT METHODOLOGY FOR STRESS TEST USED IN ASSESSMENT OF CAPITAL ADEQUACY

Article 63

General

(a) the adequacy of methods used in designing the stress tests, in accordance with Article 64;

(b) the robustness of the organisation of the stress testing process, in accordance with Article 65;

(c) the integration of the stress tests in the risk and capital management processes, in accordance with Article 66.

(a) review the institution’s internal policies, methods and procedures on the design and execution of stress test;

(b) review the institution’s outcomes of the stress test;

(c) review the roles and responsibilities of the units and management bodies involved in the designing, approval and execution of the stress test;

(d) review the relevant minutes of the institution’s internal bodies, including the management body, or committees;

(e) review the relevant findings of the internal audit or of other control functions of the institution;

(f) review the progress reports on the efforts made by the institution to correct shortcomings and mitigate risks detected during relevant audits;

(g) obtain written statements from or interview the relevant staff and senior management of the institution.

(a) review the functional documentation of the IT systems used for the stress test;

(b) request the institution to perform a computation of the stress test based on alternative assumptions;

(c) perform their own stress test calculations based on the institution’s data for certain types of exposures;

(d) review other relevant documents of the institution.

Article 64

Adequacy of methods used in designing the stress tests

(a) the tests are meaningful, reasonably conservative and capable of identifying the effects on the institution’s total capital requirements for credit risk under severe, but plausible, recession scenarios;

(b) the tests cover at least all material IRB portfolios;

(c) the methods are consistent to the extent appropriate with methods used by the institution for the purpose of internal capital allocation stress tests;

(d) the documentation of the methodology of stress tests including internal and external data as well as expert judgment input is detailed enough to allow third parties to understand the rational for the chosen scenarios and to replicate the stress test.

(a) an identification of the scenarios including severe, but plausible, recession scenarios and, the adjustment in accordance with Article 153(3) of Regulation (EU) No 575/2013, of the scenario envisaging deterioration of credit quality of protection providers;

(b) an assessment of the impact of identified scenarios on the institution’s risk parameters, rating migration, expected losses and calculation of own funds requirements for credit risk;

(c) an assessment of the adequacy of own funds requirements.

(a) the methodology for identifying a group of economic drivers;

(b) the methodology for building stress scenarios, including their severity, duration and likelihood of occurrence;

(c) the methodology for projecting the impact of each scenario on the relevant risk parameters.

Article 65

Organisation of the stress testing process

When assessing the robustness of the organisation of the stress testing process used by the institution in the assessment of the capital adequacy in accordance with Article 177 of Regulation (EU) No 575/2013, competent authorities shall verify that:

(a) the stress test is performed regularly and at least on a yearly basis;

(b) the roles and responsibilities of the unit or units in charge of the design and execution of the stress test are clearly defined;

(c) the results of stress tests are approved at an adequate management level and that senior management is informed of the results in a timely manner;

(d) the IT infrastructure effectively supports the performance of stress tests.

Article 66

Integration of the stress tests in the risk and capital management processes

When assessing the integration of the stress tests in the risk and capital management processes of the institution for the purposes of Article 177 of Regulation (EU) No 575/2013, competent authorities shall verify that:

(a) the institution takes into account the results of stress tests in its decision-making process, in particular with regard to risk and capital management;

(b) the institution takes into account the results of stress tests within the capital management process and identifies possible events or future changes in economic conditions for the purposes of capital requirements.

CHAPTER 11

ASSESSMENT METHODOLOGY FOR THE CALCULATION OF OWN FUNDS REQUIREMENTS

Article 67

General