Shearman & Sterling LLP | Financial Regulatory Developments Focus | UK Regulator Consults on Changes to Definition of Default for Credit Risk
Financial Regulatory Developments Focus
This links to the home page
  • UK Regulator Consults on Changes to Definition of Default for Credit Risk
    The Prudential Regulation Authority has opened a consultation on proposals to implement the European Banking Authority's recent regulatory products on the definition of default in the Capital Requirements Regulation. The CRR risk quantification provisions set out that a default occurs when an obligor is past due more than 90 days on any material credit obligation to a firm, its parent or any of its subsidiaries. The materiality of the credit commitment is to be assessed against a threshold set by the national regulator according to its view of a reasonable level of risk.

    The EBA developed a roadmap of regulatory products that aim to reduce unwarranted variability in the risk weighted assets calculated using banks' Internal Ratings-Based models. Three of these products pertain to the definition of default: the Regulatory Technical Standards on the materiality threshold for credit obligations past due, the Guidelines on the application of the definition of default and the EBA Opinion on the use of the 180 days past due criterion.

    The PRA is proposing to update its expectations in the Supervisory Statement 'Internal Ratings Based (IRB) approaches' (SS 11/13) and to amend the Credit Risk Part of the PRA Rulebook to set thresholds for determining whether a credit obligation is material for the purpose of the CRR's definition of default. As required by the CRR and the RTS, the PRA proposes setting materiality thresholds that it considers reflect a reasonable level of risk for retail and non-retail exposures. In particular, the PRA is intending to amend the PRA Rulebook to:

    i. set a 0% relative materiality threshold and zero absolute materiality threshold for retail exposures;

    ii. set a 1% relative materiality threshold and a sterling equivalent of €500 absolute materiality threshold for non-retail exposures;

    iii. remove the PRA's exercise of the discretion to use 180 days instead of 90 days in the 'days past due' component of the definition of default for exposures secured by residential or SME commercial real estate in the retail exposure class and/or exposures to public sector entities.

    The PRA intends to amend the relevant Supervisory Statement to reflect the EBA's Guidelines, including that it does not expect firms to replace 90 days with 180 days in the 'days past due' component of the definition of default for any exposure class.

    The proposals are relevant to U.K. banks, building societies and PRA-designated U.K. investment firms. The proposals relating to the RTS and Guidelines apply to firms using the standardized approach and firms using the IRB approach for calculating capital requirements for credit risk. The proposals relating to the EBA Opinion apply to IRB firms only.

    Responses to the consultation should be submitted by October 29, 2018. The PRA proposes that the changes will take effect from December 31 2020, in line with the EBA's proposed deadline for implementation of the EBA roadmap.

    Once the EBA has finalized the outstanding parts of the EBA roadmap, the PRA will consult on how it intends to implement them. The remaining aspects are the Guidelines on probability of default estimation, loss given default estimation and the treatment of defaulted exposures and the technical standards on specification of the nature, severity and duration of an economic downturn.

    View the consultation paper.

    View the PRA's existing Supervisory Statement (SS 11/13).

    View the PRA's existing Credit Risk Rules.

    View the EBA Opinion.

    View the RTS.

    View the EBA Guidelines.

    Return to main website.