Under the advanced internal ratings-based (IRB) approach, institutions determine their own funds requirements for credit risk taking into account their own loss given default (LGD) and conversion factor (CF) estimates. According to Article 181(1)(b) of the Capital Requirements Regulation, institutions shall estimate LGDs that are appropriate for an economic downturn and according to Article 182(1)(b) institutions shall estimate conversion factors that are appropriate for an economic downturn. The European Banking Authority (EBA) is mandated in Articles 181(3)(a) and 182(4)(a) to develop draft regulatory technical standards (RTS) specifying the nature, severity and duration of an economic downturn to be taken into account when estimating the LGD and CF.
On 22 May 2018, the EBA launched two consultations on draft RTS specifying an economic downturn and on a set of guidelines related to the estimation of LGD appropriate for conditions for an economic downturn. The deadline for comments on both consultations was 22 June 2018.
On 16 November 2018, the EBA published the final draft RTS on the specification of an economic downturn. The RTS will be submitted to the European Commission for endorsement before being published in the Official Journal of the European Union. The RTS will apply from 1 January 2021.
The EBA is currently finalising the related guidelines on the estimation of LGD appropriate for conditions of an economic downturn (which will also apply from 1 January 2021). An earlier implementation of the guidelines is, however, encouraged by the EBA which states that institutions should engage with their competent authorities at an early stage in order to determine an adequate implementation plan.