Bank of England: Credit risk mitigation: Eligibility of guarantees as unfunded credit protection

16 February 2018

This consultation paper sets out the PRA’s proposed changes to SS 17/13 ’Credit risk mitigation’ to clarify expectations regarding the eligibility of guarantees as unfunded credit protection under Part Three, Title II, Chapter 4 (Credit risk mitigation) of the Capital Requirements Regulation (CRR).

The proposals extend to any contract or other documented obligation that purports to be a guarantee for the purpose of achieving unfunded credit protection under CRR Part Three, Title II, Chapter 4.

The CP is relevant to all firms bound by the CRR.

CRR Part Three, Title II, Chapter 4 (Credit risk mitigation) sets out the criteria that a guarantee must meet to be eligible for CRM.1 These criteria include that the guarantee must be:

• Legally effective and enforceable in all relevant jurisdictions and supported by an independent, written and reasoned legal opinion.
• Clearly defined and incontrovertible.
• Without any clauses, the fulfilment of which is outside the direct control of the lender, that could render the contract ineligible for CRM. This includes any clauses that could prevent the guarantor from being obliged to pay out in a timely manner in the event where the original obligor fails to make any payments due.
• Covering all types of payments the obligor is expected to make; or where certain types of payment are excluded from the guarantee, the lending institution has adjusted the value of the guarantee to reflect the limited coverage. 

The CRR outlines two approaches for the recognition of guarantees in capital requirements for credit risk. The first is the substitution approach, and is set out in CRR Part Three, Title II, Chapter 4. It is the only approach available to exposures on the standardised approach (SA) and foundation internal ratings based approach (FIRB), and is the subject of the proposed amendments to SS17/13 in this CP. The second is an adjustment of probability of default (PD) and loss given default (LGD) for firms on the advanced internal ratings based approach (AIRB). Requirements for AIRB are different. For example, CRR requires that firms have permission from their supervisor to apply AIRB, and the PD and LGD must take account of both the ability and the willingness of the guarantor to perform. This second approach is set out in CRR Part Three, Title II, Chapter 3 (Internal ratings based approach), and is outside the scope of this CP and the proposed amendments to SS17/13.

The PRA proposes amendments to SS17/13 to provide guidance on its expectations on the eligibility criteria for the recognition of guarantees as set out in CRR Part Three, Title II, Chapter 4 (summarised in paragraph 2.1 above).

This consultation closes on Wednesday 16 May 2018.

Consultation paper

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