Future of the IRB Approach EBA Discussion Paper March 2015

Overview On 4 March 2015 the EBA has published a Discussion Paper on ‘The future of the IRB Approach’.   The EBA’s Discussion Paper follows on from its December 2013 Report on RWA Comparability and Procycliality in which the EBA concluded that the high degree of flexibility permitted by the IRB Approach has compromised the comparability of capital requirements between firms.     The EBA is planning a number of changes to the IRB Approach. The planned changes will affect virtually all aspects of the IRB Approach, including the definition of default, PD and LGD calibration, treatment of defaulted assets and scope of use of the IRB Approach and are ‘expected to result in substantial burden for both institutions and their competent authorities as regards the efforts linked to the implementation and approval of the required changes’.   The EBA has said that it is therefore consulting on the groupings and prioritisation of technical standards in order to enable the implementation of new requirements in the most operationally efficient manner. The EBA proposes four phases/groupings: Phase 1: Will be focused on the development and implementation of the EBA RTS Assessment Methodology of the IRB Approach (now – end of 2015).   Phase 2: Will be focused on the Definition of Default and the calibration or the risk parameters, PD and LGD (by mid 2016).   Phase 3:  Will be focused on the estimation or risk parameters, including PD, downturn LGD, downturn conversion factors and the treatment of defaulted assets (by the end of 2016).   Phase 4:  Will be focused on the mandates related to the CRM framework., focusing on RTS relating to (a) the recognition of conditional guarantees (b) liquid assets (c) internal models approach for  master netting agreements (by the end of 2017).   The deadline for response to the paper is 5 May 2015. Link: http://www.eba.europa.eu/documents/10180/1003460/EBA-DP-2015-01+DP+on+the+future+of+IRB+approach.pdf

Proposed Groupings and Prioritisation Overview Phase Summary of status and planned work Proposed Groupings CRR Articles Current Status Priority Implementation Timetable Phase 1: Assessment Methodology (including aspects of PPU and roll out plans, internal governance, PD, LGD, treatment of defaulted assets CBM) RTS under Articles 144(2), 173(3), 180(3b) – on the assessment methodology Consultation closed, final RTS pending 1st Phase (by the end of 2015) Application at entry into force of the RTS Phase 2: Definition of Default RTS under Article 178(6) on the materiality threshold. GL under Article 178(7) on the application of the definition of default Consultation closed, final draft RTS pending. EBA drafting the RTS Phase 2 (by the end of 2016) 2.5 years Phase 3: Estimation of Risk Parameters (including PD, downturn LGD and downturn conversion factors and the treatment of defaulted assets. The changes will be based on the modified Definition of Default. 2 years

Proposed Groupings and Prioritisation: Phase 1 (to end of 2015) Overview Phase 1 is focused on the development and implementation of the EBA RTS Assessment Methodology of the IRB Approach. The RTS will provide substantial clarification on the various areas to be addressed in Phases 2-4. The RTS will also address other aspects of the IRB Approach, including implementation of the IRB Approach and Internal Governance. The RTS will not be directly applicable to banks, but national supervisors will be required to use the methodology when carrying out assessments of the IRB Approach from when the RTS comes into force. Summary of status and planned work Topic Regulatory Products Current Status Priority Implementation Timeline Assessment Methodology, including aspects of PPU and roll out plans, internal governance, PD, LGD, treatment of defaulted assets CBM RTS under Articles 144(2), 173(3), 180(3b) – on the assessment methodology Consultation issued 1st Phase (by the end of 2015) Application at entry into force of the RTS

Proposed Groupings and Prioritisation: Phase 2 (by mid 2016) Overview Phase 2 will be focused on the Definition of Default and in particular the calibration of risk parameters, PD and LGD. The recalibration of PD and LGD envisaged will be based on an already adjusted definition of default. The EBA will require the modified Definition of Default to be implemented in both current policies and procedures and also will required historical data to be adjusted to comply with the Definition of Default. The EBA is proposing a 2-2.5 year implementation period for the adjustments of the definition of default in all relevant areas. Summary of status and planned work Topic Regulatory Products Current Status Priority Implementation Timeline Definition of Default RTS under Article 178(6) on the materiality threshold GL under Article 178(7) on the application of the definition of default The EBA is currently analysing the responses received to the consultation Phase 2 (by the end of 2016) 2.5 years

Proposed Groupings and Prioritisation: Phase 3 (by end 2016) Overview Phase 3 will focus on the estimation of risk parameters, including PD, downturn LGD and downturn conversion factors and the treatment of defaulted assets. The changes will be based on the modified Definition of Default. A 2 year implementation period is proposed. Topic Regulatory Products Current Status Priority Implementation Timeline LGD and conversion factor estimation RTS under Articles 181(3a), 182 (4a) – on the nature, severity and duration of economic downturn. Preparation of consultation paper 3rd phase (by end 2016) 2 years GL on downturn LGD calculation – EBA own initiatives (Report Article 502). PD Estimation GL on PD computation – EBA own initiatives (Report Article 502) Work not started yet Treatment of Defaulted Assets GL on LGD in default, ELBE and IRB shortfall calculation – EBA own initiatives (Report on Article 502)

Proposed Groupings and Prioritisation: Phase 4 (by end of 2017) The