New failure definition – identifying challenges in time

The European Banking Authority (EBA) has finalised the definition of default under Art. 178 CRR; its introduction is required by 2021. Although the definition of default was harmonised as part of the revision of the IRB approach, the definition is also relevant for banks that use the CRSA. In addition to the final guidelines for the definition of debtor default, the current revision also includes definitions of the materiality threshold for overdue receivables.

As a result of the heterogeneous treatment of the previous default criteria, the banking supervisory authority specified the definition of the default criteria of 90 days in arrears and unlikeliness to pay as well as the return conditions for the life portfolio in 2016. In addition, a second paper defined the threshold above which an exposure is considered significant. While the exceptions for technical defaults and factoring have been tightened, the abolition of the exception criterion "180 days in arrears" is currently recommended. The requirements for the use of external ratings have also been specified.

The requirements for the failure definition require reviewing the way in which the number of days in arrears has been counted to date and recognising the improbability of a debt being paid. In particular, the requirement for prompt, day-specific recognition of failures requires a high degree of process automation and information technology. Even if the introduction is required by 2021, timely impact studies are still essential. The greatest challenge for IRB institutes is building a failure history that is adapted to the new requirements. While adjusting the current history to the new failure definition may appear difficult due to the granularity of the data involved and the "margin of conservatism" premium that must be estimated accordingly, making timely adjustments to failure detection mechanisms is essential to establishing a new, undistorted history. In particular, the coherence of the history across all receivables classes and subsidiaries will play a special role in future audits and makes process harmonization essential.

Cross-divisional integration – a final departure from silos

The primary goal and topic of many workshops at a supraregional and cross-competence level is and remains the harmonisation of efforts at a European level. From intensive support via forbearance and NPL to failure, organisational units, processes and ultimately data are affected which are integrative--and not isolated--in the areas of risk management, controlling, reporting, accounting and overall bank management. The primary goal and topic of many workshops at a supraregional and cross-competence level is and remains the harmonisation of efforts at a European level. From intensive support via forbearance and NPL to failure, organisational units, processes and ultimately data are affected which are integrative - and not isolated - in the areas of risk management, controlling, reporting, accounting and overall bank management. Accordingly, not only terminology, but also processes and IT structures must satisfy these requirements. This was shown comprehensively and explicitly for the first time in the area of risk provisioning in the course of IFRS9--a topic that originated in accounting, but which could not be implemented in isolation without far-reaching cooperation and coordination with risk management, controlling and reporting. The following chart illustrates this relationship using the process chain "Impairment - Default - NPL":


NPL

The Risk Advisory division is happy to support your institution with both the concrete implementation of the new default definition as well as with overall harmonisation process. Reach out to us at any time for more with no obligation!