On 6 March 2019, the European Banking Authority (EBA) published its final Guidelines specifying how institutions should quantify the estimation of loss given default (LGD) appropriate for conditions of an economic downturn.
Starting from the relevant downturn period(s) identified in accordance with the related Regulatory Technical Standard (RTS), the final Guidelines set out requirements for the appropriate quantification of the calibration target used for downturn LGD estimates and include three types of approaches:
- Type 1: downturn LGD calibration based on observed impact. These approaches can be applied where sufficient loss data for the identified downturn period are available. The institution should conduct a standardised impact assessment with a prescriptive minimum scope. In this case, institutions are allowed some modelling flexibility, but subject to a harmonised and prescriptive impact assessment.
- Type 2: downturn LGD calibration based on estimated impact using historical loss data (haircut or extrapolation approach or a combination of the two). These approaches can be applied when banks do not have sufficient loss data for the identified downturn period. The institutions are allowed to choose among both approaches.
- Type 3: free modelling flexibility with minimum fixed add-on. These approaches are applied when neither type 1 nor type 2 can be applied. In this case, banks need to fulfil a minimum level of conservatism (CoM) of 15 percentage point on LGD estimates. Moreover, the institution must justify to the competent authority that it cannot apply neither the approach type 1 nor the approach type 2.
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