New Definition of Default (DoD)
- 1. Main Changes New Definition of Default (DoD) Steps to be followed by banks © 2019. For information, contact Deloitte Romania Gap analysis Perform detailed gap analysis covering all aspects of the DoD framework. Areas covered should include data, processes, systems, models and policies. Modelling Assess the impact of the new DoD on risk parameters, including the dependencies with other models. Perform re-calibrations of PDs, LGDs and EADs to the new default definition and more generally to the new requirements of the IRB regulatory roadmap. Remediation Design a remediation plan with clear timelines and responsibilities aimed at addressing the identified gaps. Documentation Review internal policies to reflect the new requirements and ensure compliance with regulations. Implementation Produce IT specifications to translate the new requirements in the internal bank’s IT systems and retrospectively apply the new default definition to the historical data. Maintain a register of the changes to the default definition. Impact assessment Conduct assessment to understand the impact on re-calibrated parameters and in terms of Risk Weighted Assets (RWA). 5 3 6 4 2 1 Impacted models New Definition of Default 3 5 4 6 2 1 IRB PD, EAD, LGD, ELBE Scorecards and Rating Models ICAAP, Risk Appetite and Credit Portfolio Management IFRS 9 models Business & Strategic Planning Stress Testing EBA GL on the application of the definition of default Past due criterion. The GL clarify aspects with regard to the counting of days past due, the technical past due situation, etc. Indications of UTP. Guidance is provided regarding the application of each indication (bankruptcy, distressed restructuring, etc.). Application of the definition of default in external data. Certain requirements are specified for institutions that use the IRB Approach and use external data for the purpose of estimating risk parameters. Criteria for the return to a non-defaulted status. The probation period and the minimum conditions for reclassification to a non- defaulted status are specified (including specific rules applying to exposures subject to distressed restructuring). Consistency. It is specified that institutions should identify the default of a single obligor consistently, and also that institutions may use different definitions of default for certain types of exposures, although differences have to be justified. Definition of default for retail exposures. The GL clarify aspects with regard to the level of application (e.g. credit facility level). Documentation and internal governance. The GL include some documentation requirements, and also governance requirements for IRB banks December 2020 RTS on the materiality threshold and NBR regulation no.5 Materiality threshold. CAs are required to set a threshold for retail and for ‘non-retail’, which will apply to all institutions in a given jurisdiction. The RTS require that this threshold is composed of both an absolute and a relative threshold. With regard to the materiality threshold, NBR requires: • for retail exposures the financial institutions shall use 1% as a relative threshold and 150 lei as an absolute threshold • for non-retail exposures the financial institutions shall use 1% as a relative threshold and 1000 lei as an absolute threshold Overview on the new definition of default Implications • Moreover, the DoD should be used at least in the area of monitoring of exposures and in the internal reporting to senior management and the management body. • Finally, the internal audit unit should review regularly the robustness and effectiveness of the process used for the identification of default. Internal policies • Institutions should recalibrate their risk parameters (PD, LGD and EAD), or at least assess the impact, which may result in the need to adapt the systems as it is necessary to redefine the historical data of default. • As the changes in the definition of default may result in reclassifications of non- defaulted exposures as defaulted, institutions should monitor the impact on capital requirements for credit risk. Impact on capital and on internal models• Institutions should review their internal policies and procedures in order to include certain aspects that should be defined. In particular, institutions should specify other additional indications of UTP, what types of arrangements are treated as bankruptcy, the treatment of joint exposures (e.g. contagious effect), etc. • Implement the specifications regarding the past due criterion and the indications of UTP. • Adjust the probation period to 3 months (1 year in the case of distressed restructuring). • Adapt the materiality threshold to the level set by CAs. • Ensure consistency in the identification of a single obligor • Institutions should adapt their methodologies and systems. Thus, among others, institutions should: Classification of exposures as defaultGovernance (for IRB institutions) • The DoD and the scope of its application are required to be approved by the management body (or by a committee) and by senior management. • Moreover, they should comply with the documentation requirements. 1 2 4 3 Scope of application Next steps EBA definition of Default intended to harmonize the default flag across the EU. All the financial institutions under the scope of CRR will have to implement the new definition of default. The implementation of GL and of the RTS is expected at the latest by end-2020.
- 2. Deloitte’s offering to your Bank can include: • Review of the methodology, functional specification, assumptions and design • Assist on required analyses and actions to implement the new definition of default • Develop/Re-develop scorecards, internal credit risk and IFRS 9 models, including macro models • Provide a holistic solution for development, validation and benchmarking • Validate internal models Key Success Factors Data and IT Centralized data definition, data quality checks, samplings of portfolios, quantify impact of known challenges. Support in the preparation of data and process flows. Organization Centralized response team and communication, kick-off meetings and an action plan. Clear responsibilities and action plan. Governance and Processes Review of key governance structures and processes to be compliant with regulatory requirements and ECB views on minimum requirements HOW CAN WE HELP Deficiencies and Issue Management Become aware of potential deficiencies by running preliminary health checks, use opportunity to understand past issues, anticipate issues and work on remedies and quantify impact Most significant changes of the IT systems Experienced professionals Senior professionals with broad-based and relevant experiences in IFRS 9 modelling, audit and risk advisory Experience and multi-dimensional exposure to the supervisory approach • The direct participation in scorecard models, IRB and IFRS 9 models development in order to be compliant with NCAs and regulatory requirements • The supervisory approach and the critical supervisory view on deficiencies is part of the inherent experience of our professionals • Deloitte has supported the supervisor in several missions with different topics and provided advice to banks in the internal models development or Comprehensive Assessment (AQR) before NCAs review… …this unique combination of different views enables Deloitte to provide substantial support in relation to validation of IRB or IFRS9 models and level of the Impairment. International Team Global resource and knowledge network: topic clarifications and refinements, training, benchmarking, exchange of technical questions and leading practices, support in all relevant jurisdictions BUCF and ECRS Collaboration on an international level through the Banking Union Center in Frankfurt (BUCF) and the EMEA Center for Regulatory Strategy (ECRS) providing fundamental views on regulatory changes and issues Dimitrios Goranitis Partner, FSI Risk & Regulatory Advisory Leader digoranitis@deloittece.com +40 751 250 684 ContactsQualification Elena Grigore Director, FSI Risk & Regulatory Advisory egrigore@deloittece.com +40 733 003 888 New Definition of Default (DoD) 4 3 2 Parallel to systems upgrades, another work- block needs to focus on the application of the new DoD on the stock of historical data in order to simulate the impact on the non-performing portfolio, as well as on parameters like PD, LGD, etc. There will be a critical need to move from a monthly to a daily storage of data tracking exposures, DPD, delayed payments, as well as UTP indicators. Readjusting the stock of default exposures is also important for recalibrating risk components. The latter will vary after the integration of the full set of new criteria for entry and exit from defaulted status.1 The changes in the systems require time for planning, development and testing. Institutions should assess the quantitative impact of the new DoD application. The systems should ensure a timely identification and automated channeling of the information on default triggers in order to treat the relevant exposure and operate the default classification of the exposure / obligor in time. The same applies for the return to non-default status. Regarding counting the days past due and the allocation of UTP reasons, the institutions should have a daily identification and a follow-up process of default triggers. The flagging of the exposures that have be marked as defaulted should not happen on the monthly basis. Contagion should be performed on a daily basis and the origin behind default triggers should be available within IT systems. With the new DoD, systems should integrate an additional condition to trigger the counting of DPD, i.e. the exceeding of both absolute and relative thresholds. This implies the ability of the system to: properly value the past due amount of an obligation; properly value the total on-balance exposure of an obligor especially in the cases of joint obligors. For institutions that decide to apply the definition of default for Retail exposures at the obligor level, the system should be parameterized to properly apply contagion between the exposures of a single obligor but also specific contagion rules for joint credit obligations. Where default is applied at obligor level, the identification of obligors and in particular “joint obligors” identification has to be consistent: the system should allow identifying a “joint obligor” as a specific set of individual obligors that have a joint obligation. The system should treat it as a different obligor, distinct from the individual obligors. This point is crucial for the correct application of materiality thresholds on joint credit obligations as well as for default contagion. Automation Daily recognition of default Materiality threshold Obligor identification Contagion Risk effectiveness and efficiency © 2019. For information, contact Deloitte Romania