NPL Risk Capital

From Open Risk Manual

Definition

NPL Risk Capital denotes the equity (own means) required to fund a portfolio of Non-Performing Loan.

NPL Risk Capital for Banks

For NPL portfolios retained in Bank balance sheets, the (minimum) risk capital requirement is determined by Basel regulations. In contrast to rules under Pillar 1 for performing credit portfolios, neither the Basel II standard nor national transpositions into law have detailed prescription about its calculation. In general there are two suggested possible approaches[1]

Independent Calculation Approach

This would be any approach that aims to calculate Unexpected Loss on the basis of internal and external data and the development of a dedicated Risk Model

Difference Between Regulatory LGD and best estimate of Expected Loss

This approach, applicable for banks having approved is based on the difference between approved internal LGD estimates (sometime called Downturn LGD) and the current Expected Loss Best Estimate (which is similar but not necessarily identical to the accounting Loss Allowance)

In EU context, EBA Guidance[2] is: The difference between the LGD In-Default and the ELBE is used for computing the risk weight according to Article 153(1)(ii) of the CRR which is then applied to the current outstanding exposure amount in order to obtain the risk weighted exposure amount. LGD In-Default denotes the estimate produced by the approved regulatory LGD model as applied after the default event. ELBE denotes the Expected Loss Best Estimate measure.

NPL Risk Capital in Securitisation

For NPL portfolios that are securitised, the risk capital requirement is derived by rating agency methodologies as the required subordination for achieving a desired rating

References

  1. BOE, Supervisory Statement SS11/13, June 2017
  2. EBA/CP/2016/21

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