EBA issues a draft RTS on the method for identifying the geographical location of credit exposures

On 2 September 2013, the EBA issued a consultation paper related to the calculation of the Counter Cyclical Buffer (CCB) for banks operating in more than one jurisdiction.

 

CRD IV requires firms to retain a countercyclical capital buffer of between 0 and 2.5% depending on the country and the individual institution.

 

For cross-border banks, the buffer rate will be a weighted average of the rates in the different countries.

Public authorities within each Member State will be responsible for setting the CCB rate within that Member State on a quarterly basis, which will be based on credit growth in relation to GDP and other relevant variables.

To establish their exact institution-specific buffer rate, banks must therefore assess the proportion of their exposures in each jurisdiction. Individual institutions will need to calculate their buffers according to the countries in their whole cross-border credit portfolio by using a combination of the rates in each country.

The institution-specific CCB rate for banks with cross-border activities will depend on the geographical location of their credit portfolios, and not on the location of the institution that hold these exposures.

  

The consultation paper identifies the ultimate risk location as the residence of the obligor rather than the location of the entity that has generated these exposures.

In fact, the EBA considers that the ultimate risk location may arise in three different ways: first, as the residence of the obligor; second, if collateral or guarantees exist, as the country where the collateral or guarantor resides; and finally, as a mix of the two depending on the structure of the credit transaction.

However, the consultation paper suggests that in general credit exposures shall be deemed to be located in the place of the obligor.

Since the purpose of the CCB is to protect the banking system against potential future losses associated with excess credit growth within the different Member States, the residence of the obligor appears more appropriate than the location of the collateral/guarantor. This is because in most cases, the residence of the obligor is more closely linked to the relevant economy, and will therefore help to build capital in the country of residence of the obligor.

The EBA is however aware that when the risk may stem from guarantees or collateral rather than from the initial obligor, the guarantor principle may better reflect the location of the ultimate risk. In fact, the location of the guarantee/collateral is still relevant for calculating capital requirements for credit risk.

The EBA does however make a notable exception in the case of specialised lending exposures. The EBA believes that the source of income would be more appropriate and has consequently chosen to deviate from the obligor principle. Therefore, in the case of specialised lending, the place of income would be the country of the location of the assets that generate the income.

 

Article 147 (8) of the CRR defines specialised lending exposures as exposures that possess the following characteristics:

a. the exposure is to an entity created specifically to finance or operate physical assets;

b. the contractual arrangements give the lender a substantial degree of control over the assets and income they generate; and

c. the primary source of repayment of the obligation is the income generated by the assets being financed, rather than the independent capacity of a broader commercial enterprise.

 

For securitisation exposures the location would be that of the obligors of the underlying exposures. If these obligors are located in multiple jurisdictions, the location of a securitisation exposure would be the jurisdiction of those obligors with the largest proportion of the underlying exposures.

Finally, the EBA is introducing a proportionality threshold of 2%. Banks with cross-border activities below 2% of their risk-weighted exposures will not be obliged to identify the geographical distribution of their exposures. Instead, all credit risk exposures can be assigned to the domestic jurisdiction of the institution.

The consultation shall run until 1 November 2013. The EBA is expected to submit this draft RTS to the European Commission for endorsement by 1 January 2014.

Contacts

Fabio Axisa
+356 2564 7214

Norbert Vella
+356 2564 7263