Section 7: Risk Quantification

EAD reference data must not be capped to the principal amount outstanding or facility limits. Accrued interest, other due payments and limit excesses should be included in EAD reference data. 16.96 For transactions that expose banks to counterparty credit risk, estimates of EAD must fulfil the requirements set forth in the counterparty credit risk standards. Requirements specific to own-EAD estimates: additional standards for corporate and sovereign exposures 16.97 Estimates of EAD must be based on a time period that must ideally cover a complete economic cycle but must in any case be no shorter than a period of seven years. If the available observation period spans a longer period for any source, and the data are relevant, this longer period must be used. EAD estimates must be calculated using a default-weighted average and not a time- weighted average. Requirements specific to own-EAD estimates: additional standards for retail exposures 16.98 The minimum data observation period for EAD estimates for retail exposures is five years. The less data a bank has, the more conservative it must be in its estimation. Requirements for assessing effect of guarantees : standards for corporate and sovereign exposures where own estimates of LGD are used and standards for retail exposures 16.99 When a bank uses its own estimates of LGD, it may reflect the risk-mitigating effect of guarantees through an adjustment to PD or LGD estimates. The option to adjust LGDs is available only to those banks that have been approved to use their own internal estimates of LGD. For retail exposures, where guarantees exist, either in support of an individual obligation or a pool of exposures, a bank may reflect the risk-reducing effect either through its estimates of PD or LGD, provided this is done consistently. In adopting one or the other technique, a bank must adopt a consistent approach, both across types of guarantees and over time. 16.100 In all cases, both the borrower and all recognized guarantors must be assigned a borrower rating at the outset and on an ongoing basis. A bank must follow all minimum requirements for assigning borrower ratings set out in this document, including the regular monitoring of the guarantor’s condition and ability and willingness to honour its obligations. Consistent with the requirements in paragraphs 16.46 and 16.47 , a bank must retain all relevant information on the borrower absent the guarantee and the guarantor. In the case of retail guarantees, these requirements also apply to the assignment of an exposure to a pool, and the estimation of PD. 16.101 In no case can the bank assign the guaranteed exposure an adjusted PD or LGD such that the adjusted risk weight would be lower than that of a comparable, direct exposure to the guarantor. Neither criteria nor rating processes are permitted to consider possible favorable effects of imperfect expected correlation between default events for the borrower and guarantor for purposes of regulatory minimum capital requirements. As such, the adjusted risk weight must not reflect the risk mitigation of “double default.” 16.102 In case the bank applies the standardized approach to direct exposures to the guarantor, the guarantee may only be recognized by treating the covered portion of the exposure as a direct exposure to the guarantor under the standardized approach. Similarly, in case the bank applies the foundation IRB approach to direct exposures to the guarantor, the guarantee may only be recognized by applying the foundation IRB approach to the covered portion of the exposure. Alternatively, banks may choose to not recognize the effect of guarantees on their exposures. 16.103 There are no restrictions on the types of eligible guarantors. The bank must, however, have clearly specified criteria for the types of guarantors it will recognize for regulatory capital purposes.