General
1. In order to assess whether the institution identifies all situations which are to be considered defaults in accordance with Article 178(1) to (5) of Regulation (EU) No 575/2013 and Commission Delegated Regulation (EU) 2018/171 ( 5 ) competent authorities shall verify all of the following:
(a)
the detailed specification and practical application of the triggers for identifying the default of an obligor, in accordance with Article 27;
(b)
the robustness and effectiveness of the process used by an institution for identifying the default of an obligor, in accordance with Article 28;
(c)
the triggers and process used by an institution for the reclassification of a defaulted obligor to non-default status, in accordance with Article 29.
2. For the purposes of the verification under paragraph 1 competent authorities shall apply all of the following methods:
(a)
review the institution’s internal criteria, policies and procedures for establishing whether a default has occurred (‘definition of default’) and for the treatment of defaulted exposures;
(b)
review the roles and responsibilities of the units and management bodies involved in the identification of the default of an obligor and the management of defaulted exposures;
(c)
review the relevant minutes of the institution’s internal bodies, including the management body, or committees;
(d)
review the relevant findings of the internal audit or of other control functions of the institution;
(e)
review the progress reports on the efforts made by the institution to correct shortcomings and mitigate risks detected during relevant audits;
(f)
obtain written statements from or interview the relevant staff and senior management of the institution;
(g)
review the criteria used by the personnel responsible for manual assignment of the default status to an obligor or an exposure and of the return to the non-default status.
3. For the purposes of the verification under paragraph 1, competent authorities may also apply any of the following additional methods:
(a)
review the functional documentation of the IT systems used in the process of identification of the default of an obligor;
(b)
conduct sample testing and review documents relating to the characteristics of an obligor and to the origination and maintenance of the exposures;
(c)
perform their own tests on the data of the institution or require the institution to perform specific tests;
(d)
review other relevant documents of the institution.
Triggers for identification of the default of an obligor
1. When assessing detailed specification and practical application of the triggers for identifying the default of an obligor applied by the institution and their compliance with Article 178(1) to (5) of Regulation (EU) No 575/2013 and Delegated Regulation (EU) 2018/171, competent authorities shall verify that:
(a)
there is an adequate policy in place with regard to the counting of days past due, including re-ageing of facilities, granting of extensions, amendments or deferrals, renewals and netting of existing accounts;
(b)
the definition of default applied by the institution includes at least all of the triggers of default set out in Article 178(1) and (3) of Regulation (EU) No 575/2013;
(c)
where an institution uses more than one definition of default within its legal entities, that the scope of application of each definition of default is clearly specified and that the differences between the definitions are justified.
2. For the purpose of the verification under paragraph 1, competent authorities shall assess whether the definition of default is implemented in practice and detailed enough to be applied consistently by all members of staff for all types of exposures, and whether all of the following potential indicators of unlikeness to pay are sufficiently specified:
(a)
the non-accrued status;
(b)
events that constitute specific credit risk adjustments resulting from a significant perceived decline in credit quality;
(c)
sales of credit obligations that constitute a material credit-related economic loss;
(d)
events that constitute a distressed restructuring;
(e)
events that constitute a similar protection to that of bankruptcy;
(f)
other indications of unlikeliness to pay.
3. Competent authorities shall verify that the policies and procedures ensure that obligors are not classified as non-defaulted where any of the default triggers apply.
Robustness and effectiveness of the process of identifying the default of an obligor
1. When assessing the robustness and effectiveness of the process of identifying the default of an obligor in accordance with Article 178 of Regulation (EU) No 575/2013, competent authorities shall verify that:
(a)
there are adequate procedures and mechanisms in place to ensure that all defaults are identified in a timely manner, in particular that the gathering and updating of relevant information are effective and take place with sufficient frequency;
(b)
where the identification of default of an obligor is based on automatic processes, tests are carried out to verify that defaults are correctly identified by the IT system;
(c)
for the purposes of identifying the default of an obligor based on human judgement, the criteria for the assessment of the obligors and triggers of default are set out in sufficient detail in the internal documentation to ensure consistency in the identification of defaults by all members of the staff involved in such identification;
(d)
where the institution applies the definition of default at the obligor level, there are adequate procedures and mechanisms in place to ensure that once default is identified for an obligor, all exposures to that obligor are registered as being in default in all relevant systems, business lines and geographical locations within the institution and its subsidiaries, and where applicable, within its parent undertaking, and its subsidiaries;
(e)
where the assignment of the default status to all exposures to an obligor as referred to in point (d) is delayed following the default of one or several exposures of the obligor, that delay does not lead to errors or inconsistencies in risk management, risk reporting, the calculation of own funds requirements or the use of data in risk quantification.
2. For the purposes of the verification under paragraph 1, competent authorities shall assess the application of the materiality threshold defined pursuant to Article 178(2)(d) of Regulation (EU) No 575/2013 in the default definition and the consistency of that materiality threshold with the materiality threshold of a credit obligation past due set by the competent authorities in accordance with Delegated Regulation (EU) 2018/171, and shall verify that:
(a)
there are adequate procedures and mechanisms in place to ensure that the default status is assigned in accordance with Article 178(1)(b) of Regulation (EU) No 575/2013 on the basis of the assessment set out in Article 178(2)(d) of that Regulation and compliant with the materiality threshold relevant to a credit obligation past due as defined by the competent authorities in accordance with Delegated Regulation (EU) 2018/171;
(b)
the process of counting days past due is consistent with the contractual or legal obligations of the obligor, reflects adequately partial payments and is applied consistently.
3. In the case of retail exposures, in addition to the verification laid down in paragraph 1 and the assessment laid down in paragraph 2, competent authorities shall verify that:
(a)
the institution has a clear policy with regard to the application of the default definition for retail exposures either at the level of the obligor or at the level of the individual credit facility;
(b)
the policy referred to in point (a) is aligned with the institution’s risk management and is applied consistently;
(c)
where the institution applies the definition of default at the level of the individual credit facility:
(i)
there are adequate procedures and mechanisms in place to ensure that once a credit facility is identified as being in default, that credit facility is marked as being in default across all relevant systems within the institution;
(ii)
where there is a time delay with regard to the assignment of the default status of a credit facility across all relevant systems as referred to in point (i), that time delay does not lead to errors or inconsistencies in risk management, risk reporting, the calculation of own funds requirements or the use of data in risk quantification.
Reclassification to non-default status
1. When assessing the robustness of the triggers and process of reclassification of a defaulted obligor to a non-default status in accordance with Article 178(5) of Regulation (EU) No 575/2013, competent authorities shall verify that:
(a)
the triggers for reclassification are determined for each trigger of default and that the identification and treatment of credit obligations subject to distressed restructuring are clearly specified;
(b)
reclassification is possible only after all triggers of default have ceased to apply and all relevant conditions for reclassification are met;
(c)
the triggers and process of reclassification are determined in a prudent way, in particular that they ensure that reclassification to a non-default status is not performed where the institution expects the credit obligation not to be paid in full without recourse by the institution to actions such as realising security.
2. For the purposes of the assessment under paragraph 1, competent authorities shall verify that the institution’s policies and procedures do not allow for reclassification of a defaulted obligor to a non-default status purely as a result of changes in the terms or conditions of the credit obligations, unless the institution has found that those changes enable the obligor to be considered as no longer being unlikely to pay.
3. Competent authorities shall verify the analysis on which the institution has based its criteria for reclassification. They shall verify that the analysis takes into account the institution’s previous default record and the percentage of the defaulted obligors that, having been reclassified to non-default status, default again within a short period of time.
Source: EUR-Lex (Publications Office of the EU), © European Union, reuse permitted under Commission Decision 2011/833/EU.
