EBA Roadmap: Credit Risk Reporting

This is the first article in a series of articles that cover various aspects of the recent EBA banking package publication.  

The EU has witnessed multiple chains of banking sector reforms in the past 3 decades, especially as part of the BCBS Basel reforms that outline various aspects of the banking system to make the sector more resilient, disciplined and structured. To further reinforce the prudential supervision in the banking sector of the European Union, the European Banking Authority (EBA) has recently published the EBA Roadmap on strengthening the prudential framework that lays down the various amendments and the introduction of new components as a part of the banking package of the final phase of Basel 3, following a political agreement between the European Parliament and the Council of European Union on 27th June 2023. 

 This banking package consists of a comprehensive set of 140 mandates encompassing various risk categories, pertinent to the banking sector such as credit risk, market risk, operational risk, ESG risk, and Governance risk. Of these 140 mandates, the category of credit risk has witnessed the highest number of mandates (43 in total), which also includes amendments and introductions in the reporting template. It is understandable that taking such changes into account by the banks could be a cumbersome procedure, as it requires policy changes and applying these in structural changes to the reporting procedures for these banks. Due to the size of the changes, this requires constant coordination amongst the individual items in the reform.  

Credit Risk Mandates: Phases of implementation

 Credit risk has been methodically segmented into four distinct phases for the implementation of these mandates:  

• The first phase is primarily about implementing the critical elements of the Standardised Approach, along with reviewing the targeted elements of the Internal Rating Based approach. This phase majorly includes the mandates related to the Standardised Approach. 
• The second phase of credit risk consists of the mandates that are mostly related to the further clarification on the Internal Ratings Based Approach and the review of the IRB repair programme products, and includes certain mandates related to the newly introduced specialised lending exposure class under the Standardised Approach.  
• The third phase of the Credit Risk reform mainly constitutes the guidelines for Credit Conversion Factor (CCF) estimation, as a complementary factor to the IRB Repair Programme. Furthermore, this phase includes multiple reports assessing the specific elements of the Basel 3 framework in the context of its EU implementation. 
• Finally, the fourth phase of Credit Risk deals with finalising the assessment of the overall proposed framework. This includes most of the mandates relating to the reports assessing the specific elements of the Basel 3 framework in the context of its overall implementation in the EU. 

EBA Credit Risk Measurement and Reporting: What has changed?

Output floor: Major extension to the IRB Approach

 With the introduction of the concept of an output floor as a bridge between the Standardised Approach and the IRB Approach, the reporting requirements for the banks under the new EBA reporting framework have undergone a substantial change in multiple areas of credit and counterparty risk sections. This output floor shall be calculated and matched against IRB exposure classes, including the ones recently included such as the exposures from Corporate Purchase Receivables, Corporate Specialised Lending, Retail qualifying revolving, retail purchase receivables, subordinated debt exposures, etc. In addition, the Standardised – Total Risk Exposure Amount (S-TREA) shall be calculated and reported for the exposures arising out of securitisations. This change is also applicable for reporting information on securitisations under the SEC Details Approach. The output floor itself will be gradually introduced from 1 January 2025 over a period of 5 years. In practice, this means that the abovementioned multiplier will gradually increase over this period, from a starting value of 50% to its final value of 72.5%.  

Exposures from Mortgages on Immovable Property

 The reporting of the exposures associated with the mortgages on immovable property has gone through multiple changes in reporting of the total exposures in both the Standardised and Internal Ratings Based Approach as part of the credit and counterparty risk. In the current reporting template as part of Basel 3.1, the exposures related to mortgages on the immovable residential and commercial property have been moved to the memorandum items.  

On the other hand, the exposures related to the mortgages on immovable property in the IRB Approach has been further deconstructed into a granular pool based on their Income Producing nature (IPRE), whether they are secured or unsecured by collateral, and whether they are residential or commercial. In addition to the mortgages on immovable property as part of the overall exposures related to the Infrastructure Sector, the category of exposures to Acquisition, Development, and Construction (ADC) as well as the Large Corporates has also been included to calculate the total exposures, hence the risk weights as part of the IRB Approach to the capital requirements. This further goes on to demonstrate that the transparency demanded by the regulators with respect to exposures in Infrastructure Sector in the banks’ own credit risk models (CR IRB) has further increased. 

Securitisations Framework

As part of Basel 4, the securitisation framework has undergone a major change. Firstly, the introduction of Simple, Transparent, and Standardised (STS) criteria by the European Union to simplify the securities transaction for the market investors, hence reducing the risks for the investors as well as reducing capital requirements for these transactions. Furthermore, a consultation paper on the amendment was released in April 2023. The primary motive of this consultation paper was to set a consistent interpretation of the terms Simple, Transparent, and Standardised, so that their understanding does not differ among the entities such as originators, original lenders, securitisation special purpose entities, etc. However, the outcome of consultation for this paper is still under discussion. 

Secondly, the revision of the hierarchy of approaches under the securitisation framework was second major change that took place. This revision was an indication of change in the prioritisation of the credibility and availability of information over the role of a bank in the Securitisation Framework.  

The new EBA guidelines highlight some of the changes in the Reporting and Disclosure procedure in the Securitisations section of the Solvency reporting template. With the advent of output floor, the exposures related to securitisations have also been included under the ambit of this revision. In the new Annex 1 Solvency reporting template, the EBA has integrated three new sections: Total Risk Exposure Amount (TREA), Output Floor S-TREA, and the Memorandum Items Output Floor Risk Weighted Exposure Amount (RWEA). In addition, the columns of Net Positions that include both the long and short position in the Securitisation template have been removed. 

Other Changes

 In addition to the above changes, the EBA banking package has further introduced some other key elements in the reporting template such as increased number of risk weight values from 14 to 24 in the Standardized Approach reporting, items such as exposures to Regional Governments or Local Authorities, Public Sector Entities or granular breakdown of exposures on specialised lending in the geographical breakdown of exposures based on the residence of obligor for the Standardised Approach, classification of the fully adjusted exposure values of the off-balance sheet items based on conversion factors under the IRB Approach (obligor grades or pools), exposure to central banks and central governments under the Standardised Approach, etc. The Solvency reporting template covers most of these changes.  

Conclusion

The transition and revision process that is expected to be carried out by the banks after a major reform in the banking regulation requires extensive due diligence, highly coordinated and unhampered communication amongst the departments, and it often requires review of the current policies and data management systems in place. All of this must be combined with a sustainable and uncompromising approach towards handling the mandates and regulations. For instance, in the recently introduced banking package, the integration of the output floor in the existing systems would most likely require an extension of the current risk model landscape to accommodate both the estimations and reporting & disclosure requirements to adapt to the reformed regulatory requirements seamlessly. Furthermore, the chronological increase in the publication of mandates which would indirectly require constant data monitoring and updating. In that regard, an active and diligent data management process along with frequent review of the reporting data is imperative to run a smooth communication of information with the regulatory authorities.  

How to deal with the final phase of Basel 3?

 Considering the above, the scope of data requirements related to all the mandates and the revised reporting & disclosure items needs to be carefully analysed and implemented accordingly. With every episode of revision in reporting requirements, it becomes imperative to identify new data points and optimise the existing external and internal reporting protocols, if necessary. Therefore, an intervention to develop a structured and flexible approach to handling such transitory processes may help in optimising the phases of procedural change, potentially for multiple years.  

 In the final phase of the introduction of the Basel 3 framework, changes such as the integration of output floor, increased granularity of reporting and the revision to the hierarchy in the securitisation framework, may require an extensive review of the current data collection practices and identification of new data points that would fulfil the reporting requirements related to these changes. For instance, the approval for IRB approach of a bank for securitized exposures requires extensive data collection pertinent to such exposures so that they are successfully clubbed under the appropriate risk weights. Moreover, transforming the data sourcing strategy as well as designing well-structured and adaptable reporting solutions often requires specialised expertise on regulatory compliance, data management, and reporting optimisation.  

How can we help?

 Our team at Mount Consulting constitutes of a team of professionals with multiple years of experience in credit risk, accounting & reporting optimization as well as business and data architecture. We have experience in the implementation of the different Basel iterations, including this final Basel 3(.5) implementation. This gives us an edge to help banks in designing the renewed value chain, including sustainable reporting procedures, as well as analysing the business and data needs in this new solution landscape. 

We believe that simply complying to the regulations by reporting the relevant data is not enough. Leveraging this momentum to create better information insights for your own processes, is what makes the difference.  

“Focus on your customers, let us worry about the regulators.”