Impacts of the new default definition according to CRIF

Starting from 2021, financial institutions (December 2020 for those directly supervised by the Bank of Italy) will be obliged to apply the guidelines on the application of the definition of default developed by the EBA (European Banking Authority), within the context of the convergence of supervisory standards that has long been committed to by EU institutions. It is an extensive topic still with some margins for uncertainty in its interpretation, and intended to interact with the guidelines on risk parameters.

Added to the many obligations required to correctly carry out supervisory reporting (regarding, for example, materiality thresholds, technical defaults, the so-called probation period or concession measures) is a complex strategic reasoning in terms of the calculation of the absorbed/released capital following alignment to the new definition, of impacts on the possibility of achieving the objectives indicated in the NPL plans shared with the Supervisory Authority within the set time limits, and of the possible impacts on the volume of adjustments required by IFRS 9 for stage 1 and stage 2 positions.

In order to take stock of possible management responses to these regulatory changes, the Credit Risk Club, in collaboration with CRIF, organized a meeting on July 1 in Milan. In the afternoon, presentations were given by representatives from the Italian and European authorities such as the EBA, the ECB and the Bank of Italy, as well as from the banking system and universities.

CRIF closed the proceedings by presenting a study on the impact of these new regulations (in particular, regulations on the new materiality thresholds and probation period) on a representative sample of the Italian banking system, comprising around 1.5 million subjects, including natural persons, sole proprietorships, partnerships and corporations. “The expected increase in defaults (in terms of numbers) is around 7.5%, in line with our expectations and with our discussions with large Italian banks,” explained Marco Macellari, Principal Management Consultant at CRIF. “The ability to quickly adjust to the new definition of default, interpreting it correctly and managing the negative repercussions, will be an important success factor for credit institutions over the next three years,” reiterated Andrea Resti of Bocconi University, senior advisor to CRIF and consultant to the European Parliament for banking supervision.

According to Macellari, the new regulations could have an uneven impact on the banking system, linked to the fact that:

• these are “two-speed” regulations, given that in the recessive phases of the economic cycle the new thresholds could have a procyclical impact, while in the expansive phases, procyclicality is clearly lower, due to the so-called “probation period”;
• the impacts on capital absorption will be different for banks that adopt a standard approach (for which there will only be a migration effect from performing to default) and for those that have an advanced internal rating-based (AIRB) system (migration, but also recalibration, in a potentially favorable sense, of the risk parameters);
• an institution that waits for a customer that has already returned to a non-default position to exit from the probation period will have a small information advantage over its competitors, for which the subject will continue to have a default status over the subsequent 90 days, more or less.

At the end of his presentation, Macellari outlined three areas where banks must invest in order to contain the impacts of the new legislation:

1. early-warning models which predict the default event and quickly intercept the negative signs, containing the effects of the deterioration;
2. more effective monitoring strategies, through more reactive management, starting from the identified isotypes;
3. new credit products or policies which “natively” enable a temporary extension of credit to a selected cluster of customers.