On 6 March 2019, the European Banking Authority (EBA) published final guidelines specifying how institutions should quantify the estimation of loss given default (LGD) appropriate for conditions of an economic downturn. In particular, the guidelines focus on requirements for the quantification of the calibration target used for downturn LGD estimation.

The guidelines are an addendum to the EBA guidelines on probability of default and LGD estimation, which are part of the EBA’s roadmap to reduce unwarranted variability of risk parameters and own funds requirements. As such, the publication of the current final guidelines completes the plan outlined in the report on the review of the internal ratings-based (IRB) approach published in February 2016. The policy for downturn LGD estimation builds on the notion of an economic downturn that is specified in the final draft regulatory technical standards on the specification of the nature, severity and duration of an economic downturn in accordance with Articles 181(3)(a) and 182(4)(a) of Capital Requirements Regulation.

The final guidelines will apply as of 1 January 2021, at the latest, but the EBA encourages earlier implementation. Institutions should engage with their competent authorities at an early stage in order to determine an adequate implementation plan, including the timeline for the supervisory assessment and approval of material model changes, where necessary.