On 21 April 2023, the European Commission published Commission Delegated Regulation (EU) of 20 April 2023, supplementing the Capital Requirements Regulation with regard to regulatory technical standards (RTS) specifying the requirements for the internal methodology or external sources used under the internal draft risk model for estimating default probabilities and losses given default.

The final draft RTS specify the requirements that an institution’s internal methodology or external sources are to fulfil for estimating probability of defaults (PDs) and loss given defaults (LGDs) in accordance with point (e) of paragraph 5 and point (d) of paragraph 6 of Article 325bp of the Capital Requirements Regulation (CRR). In particular, the requirements that an internal model should encompass all the requirements applicable to the corresponding internal ratings based (IRB) approach (i.e. the requirements set out in Section 1 of Chapter 3 of Title II of Part Three of the CRR). In addition, institutions have the possibility to use ‘fallback’ PD and LGD values under such an internal methodology, and the final draft RTS set out alternative requirements ensuring that conservative ‘fallback’ PDs and LGDs are obtained, specifying also the conditions under which these ‘fallback’ PDs and LGDs can be produced and used.

With respect to external sources, institutions are required, on the basis of these sources, to produce estimates of PDs and LGDs that are appropriate having regard to the institution’s portfolio and that are validated on a periodic basis. In addition, where more than one external source is used, a hierarchy of sources shall be established in order to ensure the overall consistency of their use. The final draft RTS also require that the methodology employed to derive the PDs and LGDs from the external sources is conceptually sound.

The Delegated Regulation enters into force on the twentieth day following that of its publication in the Official Journal of the European Union.