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Regulation (EU) No 575/2013 of the European Parliament and of the Council of 26 June 2013 on prudential requirements for credit institutions and investment firms and amending Regulation (EU) No 648/2012 Text with EEA relevance

Type Regulation

Publication 2013-06-26

Last updated 2026-06-26

State In force

Department Council of the European Union, European Parliament

Source EUR-Lex

articles 737

Reform history JSON API

EBA shall submit those draft regulatory technical standards to the Commission by 10 July 2026.

Power is delegated to the Commission to supplement this Regulation by adopting the regulatory technical standards referred to in the first subparagraph of this paragraph in accordance with Articles 10 to 14 of Regulation (EU) No 1093/2010.

Article 174

Use of models

Institutions shall use statistical or other mathematical methods (‘models’) to assign exposures to obligor or facility grades or pools. The following requirements shall be met:

(a) the model shall have good predictive power and own funds requirements shall not be distorted as a result of its use;

(b) the institution shall have in place a process for vetting data inputs into the model, which includes an assessment of the accuracy, completeness and appropriateness of the data;

(c) the data used to build the model shall be representative of the population of the institution's actual obligors or exposures;

(d) the institution shall have a regular cycle of model validation that includes monitoring of model performance and stability; review of model specification; and testing of model outputs against outcomes;

(e) the institution shall complement the statistical model by human judgement and human oversight to review model-based assignments and to ensure that the models are used appropriately. Review procedures shall aim at finding and limiting errors associated with model weaknesses. Human judgements shall take into account all relevant information not considered by the model. The institution shall document how human judgement and model results are to be combined.

For the purposes of the first paragraph, point (a), the input variables shall form a reasonable and effective basis for the resulting predictions. The model shall not have material biases. There shall be a functional link between the inputs and the outputs of the model, which may be determined through expert judgement, where appropriate.

Article 175

Documentation of rating systems

Where the institution employs statistical models in the rating process, the institution shall document their methodologies. This material shall:

(a) provide a detailed outline of the theory, assumptions and mathematical and empirical basis of the assignment of estimates to grades, individual obligors, exposures, or pools, and the data source(s) used to estimate the model;

(b) establish a rigorous statistical process including out-of-time and out-of-sample performance tests for validating the model;

Article 176

Data maintenance

For exposures to central governments and central banks, exposures to regional governments, local authorities and public sector entities, exposures to institutions and exposures to corporates, institutions shall collect and store:

(a) complete rating histories on obligors and recognised guarantors;

(b) the dates the ratings were assigned;

(d) the person responsible for the rating assignment;

(e) the identity of obligors and exposures that defaulted;

(f) the date and circumstances of such defaults;

(g) data on the PDs and realised default rates associated with rating grades and ratings migration.

Institutions using own estimates of LGDs and conversion factors shall collect and store:

(a) complete histories of data on the facility ratings and LGD and conversion factor estimates associated with each rating scale;

(b) the dates on which the ratings were assigned and the estimates were made;

(d) the person who assigned the facility rating and the person who provided LGD and conversion factor estimates;

(e) data on the estimated and realised LGDs and conversion factors associated with each defaulted exposure;

(f) data on the LGD of the exposure before and after evaluation of the effects of a guarantee/or credit derivative, for those institutions that reflect the credit risk mitigating effects of guarantees or credit derivatives through LGD;

(g) data on the components of loss for each defaulted exposure.

For retail exposures, institutions shall collect and store:

(a) data used in the process of allocating exposures to grades or pools;

(b) data on the estimated PDs, LGDs and conversion factors associated with grades or pools of exposures;

(d) for defaulted exposures, data on the grades or pools to which the exposure was assigned over the year prior to default and the realised outcomes on LGD and conversion factor;

(e) data on loss rates for qualifying revolving retail exposures.

Article 177

Stress tests used in assessment of capital adequacy

EBA shall issue guidelines, in accordance with Article 16 of Regulation (EU) No 1093/2010, on the application of paragraph 2 and 2a.

Sub-Section 2

Risk quantification

Article 178

Default of an obligor or credit facility

A default shall be considered to have occurred with regard to a particular obligor when either or both of the following have taken place:

(a) the institution considers that the obligor is unlikely to pay its credit obligations to the institution, the parent undertaking or any of its subsidiaries in full, without recourse by the institution to actions such as realising security;

(b) the obligor is more than 90 days past due on any material credit obligation to the institution, the parent undertaking or any of its subsidiaries.

In the case of retail exposures, institutions may apply the definition of default laid down in points (a) and (b) of the first subparagraph at the level of an individual credit facility rather than in relation to the total obligations of a borrower.

The following shall apply for the purposes of point (b) of paragraph 1:

(a) for overdrafts, days past due commence once an obligor has breached an advised limit, has been advised a limit smaller than current outstandings, or has drawn credit without authorisation and the underlying amount is material;

(b) for the purposes of point (a), an advised limit comprises any credit limit determined by the institution and about which the obligor has been informed by the institution;

(d) materiality of a credit obligation past due shall be assessed against a threshold, defined by the competent authorities. This threshold shall reflect a level of risk that the competent authority considers to be reasonable;

(e) institutions shall have documented policies in respect of the counting of days past due, in particular in respect of the re-ageing of the facilities and the granting of extensions, amendments or deferrals, renewals, and netting of existing accounts. These policies shall be applied consistently over time, and shall be in line with the internal risk management and decision processes of the institution.

For the purpose of point (a) of paragraph 1, elements to be taken as indications of unlikeliness to pay shall include the following:

(a) the institution puts the credit obligation on non-accrued status;

(b) the institution recognises a specific credit adjustment resulting from a significant perceived decline in credit quality subsequent to the institution taking on the exposure;

(d) the institution consents to a forbearance measure as referred to in Article 47b of the credit obligation where that measure is likely to result in a diminished financial obligation due to the material forgiveness, or postponement, of principal, interest or, where relevant, fees;

(e) the institution has filed for the obligor's bankruptcy or a similar order in respect of an obligor's credit obligation to the institution, the parent undertaking or any of its subsidiaries;

(f) the obligor has sought or has been placed in bankruptcy or similar protection where this would avoid or delay repayment of a credit obligation to the institution, the parent undertaking or any of its subsidiaries.

EBA shall submit those draft regulatory technical standards to the Commission by 31 December 2014.

Power is delegated to the Commission to adopt the regulatory technical standards referred to in the first subparagraph in accordance with Articles 10 to 14 of Regulation (EU) No 1093/2010.

By 10 July 2025, EBA shall issue guidelines, in accordance with Article 16 of Regulation (EU) No 1093/2010, to update the guidelines referred to in the first subparagraph of this paragraph. In particular, that update shall take due account of the necessity to encourage institutions to engage in proactive, preventive and meaningful debt restructuring to support obligors.

In developing those guidelines, EBA shall duly consider the need for granting a sufficient flexibility to institutions when specifying what constitutes a diminished financial obligation for the purposes of paragraph 3, point (d).

Article 179

Overall requirements for estimation

In quantifying the risk parameters to be associated with rating grades or pools, institutions shall apply the following requirements:

(a) an institution's own estimates of the risk parameters PD, LGD, conversion factor and EL shall incorporate all relevant data, information and methods. The estimates shall be derived using both historical experience and empirical evidence, and not based purely on judgemental considerations. The estimates shall be plausible and intuitive and shall be based on the material drivers of the respective risk parameters. The less data an institution has, the more conservative it shall be in its estimation;

(b) an institution shall be able to provide a breakdown of its loss experience in terms of default frequency, LGD, conversion factor, or loss where EL estimates are used, by the factors it sees as the drivers of the respective risk parameters. The institution's estimates shall be representative of long run experience;

(c) any changes in lending practice or the process for pursuing recoveries over the observation periods referred to in Article 180(1)(h) and (2)(e), Article 181(1)(j) and (2), and Article 182(2) and (3) shall be taken into account. An institution's estimates shall reflect the implications of technical advances and new data and other information, as it becomes available. Institutions shall review their estimates when new information comes to light but at least on an annual basis;

(d) the population of exposures represented in the data used for estimation, the lending standards used when the data was generated and other relevant characteristics shall be comparable with those of the institution's exposures and standards. The economic or market conditions that underlie the data shall be relevant to current and foreseeable conditions. The number of exposures in the sample and the data period used for quantification shall be sufficient to provide the institution with confidence in the accuracy and robustness of its estimates;

(e) for purchased receivables the estimates shall reflect all relevant information available to the purchasing institution regarding the quality of the underlying receivables, including data for similar pools provided by the seller, by the purchasing institution, or by external sources. The purchasing institution shall evaluate any data relied upon which is provided by the seller;

(f) to overcome biases, an institution shall include appropriate adjustments in its estimates to the extent possible; after having included an appropriate adjustment, it shall add to its estimates a sufficient margin of conservatism that is related to the expected range of estimation errors; where methods and data are considered to be less satisfactory, the expected range of errors is larger, and the margin of conservatism shall be larger.

Where institutions use different estimates for the calculation of risk weights and for internal purposes, it shall be documented and be reasonable. If institutions can demonstrate to their competent authorities that for data that have been collected prior to 1 January 2007 appropriate adjustments have been made to achieve broad equivalence with the definition of default laid down in Article 178 or with loss, competent authorities may permit the institutions some flexibility in the application of the required standards for data.

Where an institution uses data that is pooled across institutions it shall meet the following requirements:

(a) the rating systems and criteria of other institutions in the pool are similar to its own;

(b) the pool is representative of the portfolio for which the pooled data is used;

(d) the institution shall remain responsible for the integrity of its rating systems;

(e) the institution shall maintain sufficient in-house understanding of its rating systems, including the ability to effectively monitor and audit the rating process.

Article 180

Requirements specific to PD estimation

In quantifying the risk parameters to be associated with rating grades or pools, institutions shall apply the following requirements specific to PD estimation to exposures to central governments and central banks, exposures to regional governments, local authorities and public sector entities, exposures to institutions and exposures to corporates:

(a) institutions shall estimate PDs by obligor grade from long run averages of one-year default rates. PD estimates for obligors that are highly leveraged or for obligors whose assets are predominantly traded assets shall reflect the performance of the underlying assets based on periods of stressed volatilities;

(b) for purchased corporate receivables institutions may estimate the EL by obligor grade from long run averages of one-year realised default rates;

(c) if an institution derives long run average estimates of PDs and LGDs for purchased corporate receivables from an estimate of EL, and an appropriate estimate of PD or LGD, the process for estimating total losses shall meet the overall standards for estimation of PD and LGD set out in this part, and the outcome shall be consistent with the concept of LGD as set out in Article 181(1)(a);

(d) institutions shall use PD estimation techniques only with supporting analysis. Institutions shall recognise the importance of judgmental considerations in combining results of techniques and in making adjustments for limitations of techniques and information;

(e) to the extent that an institution uses data on internal default experience for the estimation of PDs, the estimates shall be reflective of current underwriting standards and of any differences in the rating system that generated the data and the current rating system; where underwriting standards or rating systems have changed, after including an appropriate adjustment, the institution shall add a greater margin of conservatism in its estimate of PD related to the expected range of estimation errors that is not already covered by the appropriate adjustment;

(f) to the extent that an institution associates or maps its internal grades to the scale used by an ECAI or similar organisations and then attributes the default rate observed for the external organisation's grades to the institution's grades, mappings shall be based on a comparison of internal rating criteria to the criteria used by the external organisation and on a comparison of the internal and external ratings of any common obligors. Biases or inconsistencies in the mapping approach or underlying data shall be avoided. The criteria of the external organisation underlying the data used for quantification shall be oriented to default risk only and not reflect transaction characteristics. The analysis undertaken by the institution shall include a comparison of the default definitions used, subject to the requirements in Article 178. The institution shall document the basis for the mapping;

(g) to the extent that an institution uses statistical default prediction models it is allowed to estimate PDs as the simple average of default-probability estimates for individual obligors in a given grade. The institution's use of default probability models for this purpose shall meet the standards specified in Article 174;

(h) irrespective of whether an institution is using external, internal, or pooled data sources, or a combination of the three, for its PD estimation, the length of the underlying historical observation period used shall be at least five years for at least one source;

(i) irrespective of the method used to estimate PD, institutions shall estimate a PD for each rating grade based on the observed historical average one-year default rate that is an arithmetic average based on the number of obligors (count weighted); other approaches, including exposure-weighted averages, shall not be permitted.

For the purposes of the first subparagraph, point (h), of this paragraph where the available observation period spans a longer period for any source, and where those data are relevant, that longer period shall be used. The data shall include a representative mix of good and bad years of the economic cycle relevant for the type of exposures. Subject to the permission of competent authorities, institutions which have not received the permission of the competent authority pursuant to Article 143 to use own estimates of LGD or to use IRB-CCF, may use, when they implement the IRB Approach, relevant data covering a period of two years. The period to be covered shall be increased by one year each year until relevant data cover at least five years.

For retail exposures, the following requirements shall apply:

(a) institutions shall estimate PDs by obligor or facility grade or pool from long run averages of one-year default rates, and default rates shall be calculated at facility level only where the definition of default is applied at individual credit facility level pursuant to Article 178(1), second subparagraph;

(b) PD estimates may also be derived from an estimate of total losses and appropriate estimates of LGDs;

(c) institutions shall regard internal data for assigning exposures to grades or pools as the primary source of information for estimating loss characteristics. Institutions may use external data (including pooled data) or statistical models for quantification provided that the following strong links both exist: (i) between the institution's process of assigning exposures to grades or pools and the process used by the external data source; and (ii) between the institution's internal risk profile and the composition of the external data;

(d) if an institution derives long run average estimates of PD and LGD for retail exposures from an estimate of total losses and an appropriate estimate of PD or LGD, the process for estimating total losses shall meet the overall standards for estimation of PD and LGD set out in this part, and the outcome shall be consistent with the concept of LGD as set out in point (a) of Article 181(1);

(e) irrespective of whether an institution is using external, internal or pooled data sources, or a combination of the three, for its PD estimation, the length of the underlying historical observation period used shall be at least five years for at least one source;

(f) institutions shall identify and analyse expected changes of risk parameters over the life of credit exposures (seasoning effects).

For purchased retail receivables, institutions may use external and internal reference data. Institutions shall use all relevant data sources as points of comparison.

For the purposes of the first subparagraph, point (a), the PD shall be based on the observed historical average one-year default rate.

For the purposes of the first subparagraph, point (e), where the available observation spans a longer period for any source, and where those data are relevant, that longer period shall be used. The data shall include a representative mix of good and bad years of the economic cycle relevant for the type of exposures. Subject to the permission of the competent authorities, institutions may use, when they implement the IRB Approach, relevant data covering a period of two years. The period to be covered shall be increased by one year each year until relevant data cover at least five years.

EBA shall submit those draft regulatory technical standards to the Commission by 10 July 2026.

Article 181

Requirements specific to own-LGD estimates

In quantifying the risk parameters to be associated with rating grades or pools, institutions shall apply the following requirements specific to own-LGD estimates:

(a) institutions shall estimate LGDs by facility grade or pool on the basis of the average realised LGDs by facility grade or pool using all observed defaults within the data sources (default weighted average);

(b) institutions shall use LGD estimates that are appropriate for an economic downturn if those are more conservative than the long-run average. To the extent a rating system is expected to deliver realised LGDs at a constant level by grade or pool over time, institutions shall make adjustments to their estimates of risk parameters by grade or pool to limit the capital impact of an economic downturn;

(c) an institution shall consider the extent of any dependence between, on the one hand, the risk of the obligor and, on the other hand, that of funded credit protection, other than master netting agreements and on-balance-sheet netting of loans and deposits, or its provider;

(d) currency mismatches between the underlying obligation and the funded credit protection other than master netting agreements and on-balance-sheet netting of loans and deposits shall be treated conservatively in the institution’s assessment of LGD;

(e) to the extent that LGD estimates take into account the existence of funded credit protection other than master netting agreements and on-balance-sheet netting of loans and deposits, those estimates shall not solely be based on the estimated market value of the funded credit protection;

(f) to the extent that LGD estimates take into account the existence of funded credit protection other than master netting agreements and on-balance-sheet netting of loans and deposits, institutions shall establish internal requirements for the management, legal certainty and risk management of that funded credit protection, and those requirements shall be generally consistent with those set out in Chapter 4, Section 3, Sub-section 1;

(g) to the extent that an institution recognises funded credit protection other than master netting agreements and on-balance-sheet netting of loans and deposits for determining the exposure value for counterparty credit risk in accordance with Chapter 6, Section 5 or 6, any amount expected to be recovered from that funded credit protection shall not be taken into account in the LGD estimates;

(h) for the specific case of exposures already in default, the institution shall use the sum of its best estimate of expected loss for each exposure given current economic circumstances and exposure status and its estimate of the increase of loss rate caused by possible additional unexpected losses during the recovery period, i.e. between date of default and final liquidation of the exposure;

(i) to the extent that fees for late payments, imposed on the obligor before the time of default, have been capitalised in the institution’s income statement, they shall be added to the institution's measure of exposure and loss;

(j) for exposures to corporates, institutions, central governments and central banks, and regional governments, local authorities and public sector entities, estimates of LGD shall be based on data over a minimum of five years, increasing by one year each year after implementation until a minimum of seven years is reached, for at least one data source, if the available observation period spans a longer period for any source, and the data are relevant, that longer period shall be used.

For the purposes of the first subparagraph, point (a), of this paragraph institutions shall adequately take into account recoveries realised in the course of the relevant recovery processes from any type of funded credit protection as well as from unfunded credit protection not falling under the definition in Article 142(1), point (10).

For the purposes of the first subparagraph, point (c), cases where there is a significant degree of dependence shall be addressed in a conservative manner.

For the purposes of the first subparagraph, point (e), LGD estimates shall take into account the effect of the potential inability of institutions to expeditiously gain control of their collateral and liquidate it.

For retail exposures, institutions may do the following:

(a) derive LGD estimates from realised losses and appropriate estimates of PDs;

(b) reflect future drawings either in their conversion factors or in their LGD estimates;

For the purposes of the first subparagraph, point (b), where institutions include future additional drawings in their conversion factors, those should be taken into account in the LGD in both the numerator and the denominator. Where institutions do not include future additional drawings in their conversion factors, those should be taken into account in the LGD numerator only.

For retail exposures, estimates of LGD shall be based on data over a minimum of five years. Subject to the permission of the competent authorities, institutions may use, when they implement the IRB Approach, relevant data covering a period of two years. The period to be covered shall be increased by one year each year until relevant data cover at least five years.

EBA shall develop draft regulatory technical standards to specify the following:

(a) the nature, severity and duration of an economic downturn referred to in paragraph 1;

(b) the conditions according to which a competent authority may permit an institution pursuant to paragraph 2 to use relevant data covering a period of two years when the institution implements the IRB Approach.

EBA shall submit those draft regulatory technical standards to the Commission by 31 December 2014.

Power is delegated to the Commission to adopt the regulatory technical standards referred to in the first subparagraph in accordance with Articles 10 to 14 of Regulation (EU) No 1093/2010.

For the purpose of calculating loss, EBA shall, by 31 December 2025, issue updated guidelines, in accordance with Article 16 of Regulation (EU) No 1093/2010, on the following:

(a) with regard to cases that return to non-defaulted status, specifying how artificial cash flow is to be treated and whether it is more appropriate for institutions to discount the artificial cash flow over the actual period of default;

(b) assessing whether the calibration and application of the discount rate is appropriate for the calculation of economic loss across all exposures.

Article 182

Requirements specific to own-conversion factor estimates

In quantifying the risk parameters to be associated with rating grades or pools, institutions shall apply the following requirements specific to own-conversion factor estimates:

(a) institutions shall estimate conversion factors by facility grade or pool on the basis of the average realised conversion factors by facility grade or pool using the default weighted average resulting from all observed defaults within the data sources;

(b) institutions shall use conversion factor estimates that are appropriate for an economic downturn if those are more conservative than the long-run average. To the extent a rating system is expected to deliver realised conversion factors at a constant level by grade or pool over time, institutions shall make adjustments to their estimates of risk parameters by grade or pool to limit the capital impact of an economic downturn;

(c) institutions’ IRB-CCF shall reflect the possibility of additional drawings by the obligor up to and after the time a default event is triggered;

(d) in arriving at estimates of conversion factors institutions shall consider their specific policies and strategies adopted in respect of account monitoring and payment processing. Institutions shall also consider their ability and willingness to prevent further drawings in circumstances short of payment default, such as covenant violations or other technical default events;

(e) institutions shall have adequate systems and procedures in place to monitor facility amounts, current outstandings against committed lines and changes in outstandings per obligor and per grade. The institution shall be able to monitor outstanding balances on a daily basis;

(f) if institutions use different estimates of conversion factors for the calculation of risk-weighted exposure amounts and internal purposes it shall be documented and be reasonable;

(g) institutions’ IRB-CCF shall be estimated using a 12-month fixed-horizon approach;

(h) institutions’ IRB-CCF shall be based on reference data that reflect the obligor, facility and bank management practice characteristics of the exposures to which the estimates are applied.

For the purposes of the first subparagraph, point (a), where institutions observe a negative realised conversion factor on their default observations, the realised conversion factor on those observations shall be equal to zero for the purpose of quantification of their IRB-CCF. Institutions may use the information of the negative realised conversion factor in the process of model development for the purpose of risk differentiation.

For the purposes of the first subparagraph, point (c), IRB-CCF shall incorporate a greater margin of conservatism where a stronger positive correlation can reasonably be expected between the default frequency and the magnitude of the conversion factor.

For the purposes of the first subparagraph, point (g), each default shall be linked to relevant obligor and facility characteristics at the fixed reference date defined as 12 months prior to the date of default.

For the purposes of paragraph 1, point (h), IRB-CCF applied to particular exposures shall not be based on data that comingle the effects of disparate characteristics or data from exposures that exhibit materially different risk characteristics. IRB-CCF shall be based on appropriately homogenous segments. For that purpose, the following practices shall only be allowed on the basis of a detailed scrutiny and justification by an institution:

(a) SME/mid-market underlying data being applied to large corporate obligors;

(b) data from commitments with a small unused limit availability being applied to facilities with a large unused limit availability;

(c) data from delinquent obligors or blocked for further drawdowns at the reference date being applied to obligors with no known delinquency or relevant restrictions;

(d) data that have been affected by changes in the obligors’ mix of borrowing and other credit-related products over the observation period unless those data have been effectively adjusted by removing the effects of the changes in the product mix.

For the purposes of paragraph 1a, point (d), institutions shall demonstrate to the competent authorities that they have a detailed understanding of the impact of changes in customer product mix on the exposures reference data sets and associated IRB-CCF, and that the impact is immaterial or has been effectively mitigated within their estimation process. In that regard, the following shall not be deemed appropriate:

(a) setting floors or caps to CCF or exposure value observations, with the exception of the realised conversion factor equal to zero, in accordance with paragraph 1, second subparagraph;

(b) using obligor-level estimates that do not fully cover the relevant product transformation options or that inappropriately combine products with very different characteristics;

(d) excluding observations affected by product profile transformation.

For retail exposures, estimates of conversion factors shall be based on data over a minimum of five years. Subject to the permission of competent authorities, institutions may use, when they implement the IRB Approach, relevant data covering a period of two years. The period to be covered shall be increased by one year each year until relevant data cover at least five years.

EBA shall develop draft regulatory technical standards to specify the following:

(a) the nature, severity and duration of an economic downturn referred to in paragraph 1;

(b) conditions according to which a competent authority may permit and institution to use relevant data covering a period of two years at the time an institution first implements the IRB Approach.

EBA shall submit those draft regulatory technical standards to the Commission by 31 December 2014.

Power is delegated to the Commission to adopt the regulatory technical standards referred to in the first subparagraph in accordance with Articles 10 to 14 of Regulation (EU) No 1093/2010.

Article 183

Requirements for assessing the effect of unfunded credit protection for exposures to central governments and central banks, exposures to regional governments, local authorities and public sector entities, and exposures to corporates, where own estimates of LGD are used and for retail exposures

The following requirements shall apply in relation to eligible guarantors and guarantees:

(a) institutions shall have clearly specified criteria for the types of guarantors they recognise for the calculation of risk-weighted exposure amounts;

(b) for recognised guarantors the same rules as for obligors as set out in Articles 171, 172 and 173 shall apply;

(c) the guarantee shall be evidenced in writing, non-cancellable and non-changeable on the part of the guarantor, in force until the obligation is satisfied in full, to the extent of the amount and tenor of the guarantee, and legally enforceable against the guarantor in a jurisdiction where the guarantor has assets to attach and enforce a judgement;

(d) the guarantee shall be unconditional.

For the purposes of the first subparagraph, point (d), an ‘unconditional guarantee’ means a guarantee where the credit protection contract does not contain any clause the fulfilment of which is outside the direct control of the lending institution and that could prevent the guarantor from being obliged to pay out in a timely manner pursuant to the qualifying default of the obligor or to the non-payment by the original obligor. A clause in the credit protection contract providing that a flawed due diligence or fraud by the lending institution cancels or diminishes the extent of the guarantee offered by the guarantor shall not disqualify that guarantee from being considered unconditional.

Guarantees where the payment by the guarantor is subject to the lending institution first having to pursue the obligor and that only cover losses remaining after the institution has completed the workout process shall be considered unconditional.

The criteria shall be plausible and intuitive. They shall address the guarantor's ability and willingness to perform under the guarantee, the likely timing of any payments from the guarantor, the degree to which the guarantor's ability to perform under the guarantee is correlated with the obligor's ability to repay, and the extent to which residual risk to the obligor remains.

The criteria shall address the payout structure of the credit derivative and conservatively assess the impact this has on the level and timing of recoveries. The institution shall consider the extent to which other forms of residual risk remain.

First-to-default credit derivatives may be recognised as eligible unfunded credit protection. However, second-to-default and all other nth-to-default credit derivatives shall not be recognised as eligible unfunded credit protection.

Article 184

Requirements for purchased receivables

The institution shall monitor both the quality of the purchased receivables and the financial condition of the seller and servicer. The following shall apply:

(a) the institution shall assess the correlation among the quality of the purchased receivables and the financial condition of both the seller and servicer, and have in place internal policies and procedures that provide adequate safeguards to protect against any contingencies, including the assignment of an internal risk rating for each seller and servicer;

(b) the institution shall have clear and effective policies and procedures for determining seller and servicer eligibility. The institution or its agent shall conduct periodic reviews of sellers and servicers in order to verify the accuracy of reports from the seller or servicer, detect fraud or operational weaknesses, and verify the quality of the seller's credit policies and servicer's collection policies and procedures. The findings of these reviews shall be documented;

(c) the institution shall assess the characteristics of the purchased receivables pools, including over-advances; history of the seller's arrears, bad debts, and bad debt allowances; payment terms, and potential contra accounts;

(d) the institution shall have effective policies and procedures for monitoring on an aggregate basis single-obligor concentrations both within and across purchased receivables pools;

(e) the institution shall ensure that it receives from the servicer timely and sufficiently detailed reports of receivables ageings and dilutions to ensure compliance with the institution's eligibility criteria and advancing policies governing purchased receivables, and provide an effective means with which to monitor and confirm the seller's terms of sale and dilution.

Sub-Section 3

Validation of internal estimates

Article 185

Validation of internal estimates

Institutions shall validate their internal estimates subject to the following requirements:

(a) institutions shall have robust systems in place to validate the accuracy and consistency of rating systems, processes, and the estimation of all relevant risk parameters. The internal validation process shall enable the institution to assess the performance of internal rating and risk estimation systems consistently and meaningfully;

(b) institutions shall regularly compare realised default rates with estimated PDs for each grade and, where realised default rates are outside the expected range for that grade, institutions shall specifically analyse the reasons for the deviation. Institutions using own estimates of LGDs and conversion factors shall also perform analogous analysis for these estimates. Such comparisons shall make use of historical data that cover as long a period as possible. The institution shall document the methods and data used in such comparisons. This analysis and documentation shall be updated at least annually;

(c) institutions shall also use other quantitative validation tools and comparisons with relevant external data sources. The analysis shall be based on data that are appropriate to the portfolio, are updated regularly, and cover a relevant observation period. Institutions' internal assessments of the performance of their rating systems shall be based on as long a period as possible;

(d) the methods and data used for quantitative validation shall be consistent through time. Changes in estimation and validation methods and data (both data sources and periods covered) shall be documented;

(e) institutions shall have sound internal standards for situations where deviations in realised PDs, LGDs, conversion factors and total losses, where EL is used, from expectations, become significant enough to call the validity of the estimates into question. These standards shall take account of business cycles and similar systematic variability in default experience. Where realised values continue to be higher than expected values, institutions shall revise estimates upward to reflect their default and loss experience;

Sub-Section 5

Internal governance and oversight

Article 189

Corporate Governance

Senior management shall be subject to the following requirements:

(a) they shall provide notice to the management body or a designated committee thereof of material changes or exceptions from established policies that will materially impact the operations of the institution's rating systems;

(b) they shall have a good understanding of the rating systems designs and operations;

Senior management shall be regularly informed by the credit risk control units about the performance of the rating process, areas needing improvement, and the status of efforts to improve previously identified deficiencies.

Article 190

Credit risk control

The areas of responsibility for the credit risk control unit or units shall include:

(a) testing and monitoring grades and pools;

(b) production and analysis of summary reports of the institution's rating systems;

(c) implementing procedures to verify that grade and pool definitions are consistently applied across departments and geographic areas;

(d) reviewing and documenting any changes to the rating process, including the reasons for the changes;

(e) reviewing the rating criteria to evaluate if they remain predictive of risk. Changes to the rating process, criteria or individual rating parameters shall be documented and retained;

(f) active participation in the design or selection, implementation and validation of models used in the rating process;

(g) oversight and supervision of models used in the rating process;

(h) ongoing review and alterations to models used in the rating process.

Institutions using pooled data in accordance with Article 179(2) may outsource the following tasks:

(a) production of information relevant to testing and monitoring grades and pools;

(b) production of summary reports of the institution's rating systems;

(d) documentation of changes to the rating process, criteria or individual rating parameters;

(e) production of information relevant to ongoing review and alterations to models used in the rating process.

Article 191

Internal Audit

Internal audit or another comparable independent auditing unit shall review at least annually the institution's rating systems and its operations, including the operations of the credit function and the estimation of PDs, LGDs, ELs and conversion factors. Areas of review shall include adherence to all applicable requirements.

CHAPTER 4

Credit risk mitigation

Section 1

Definitions and general requirements

Article 192

Definitions

For the purposes of this Chapter, the following definitions shall apply:

(1) ‘lending institution’ means the institution which has the exposure in question;

(2) ‘secured lending transaction’ means any transaction giving rise to an exposure secured by collateral which does not include a provision conferring upon the institution the right to receive margin at least daily;

(3) ‘capital market-driven transaction’ means any transaction giving rise to an exposure secured by collateral which includes a provision conferring upon the institution the right to receive margin at least daily;

(4) ‘underlying CIU’ means a CIU in the shares or units of which another CIU has invested;

(5) ‘substitution of risk parameters approach under A-IRB’ means the substitution, in accordance with Article 236a, of both the PD and LGD risk parameters of the underlying exposure with the corresponding PD and LGD that would be assigned under the IRB approach using own estimates of LGD to a comparable direct exposure to the protection provider.

Article 193

Principles for recognising the effect of credit risk mitigation techniques

Where an institution calculating risk-weighted exposure amounts under the Standardised Approach has more than one form of credit risk mitigation covering a single exposure it shall do both of the following:

(a) subdivide the exposure into parts covered by each type of credit risk mitigation tool;

(b) calculate the risk-weighted exposure amount for each part obtained in point (a) separately in accordance with the provisions of Chapter 2 and this Chapter.

When an institution calculating risk-weighted exposure amounts under the Standardised Approach covers a single exposure with credit protection provided by a single protection provider and that protection has differing maturities, it shall do both of the following:

(a) subdivide the exposure into parts covered by each credit risk mitigation tool;

(b) calculate the risk-weighted exposure amount for each part obtained in point (a) separately in accordance with the provisions of Chapter 2 and this Chapter.

Article 194

Principles governing the eligibility of credit risk mitigation techniques

The lending institution shall provide, upon request of the competent authority, the most recent version of the independent, written and reasoned legal opinion or opinions that it used to establish whether its credit protection arrangement or arrangements meet the condition laid down in the first subparagraph.

Institutions may recognise funded credit protection in the calculation of the effect of credit risk mitigation only where the assets relied upon for protection meet both of the following conditions:

(a) they are included in the list of eligible assets set out in Articles 197 to 200, as applicable;

(b) they are sufficiently liquid and their value over time sufficiently stable to provide appropriate certainty as to the credit protection achieved having regard to the approach used to calculate risk-weighted exposure amounts and to the degree of recognition allowed.

In the case of unfunded credit protection, a protection agreement shall qualify as an eligible protection agreement only where it meets both the following conditions:

(a) it is included in the list of eligible protection agreements set out in Articles 203 and 204(1);

(b) it is legally effective and enforceable in the relevant jurisdictions, to provide appropriate certainty as to the credit protection achieved having regard to the approach used to calculate risk-weighted exposure amounts and to the degree of recognition allowed;

Section 2

Eligible forms of credit risk mitigation

Sub-Section 1

Funded credit protection

Article 195

On-balance sheet netting

An institution may use on-balance sheet netting of mutual claims between itself and its counterparty as an eligible form of credit risk mitigation.

Without prejudice to Article 196, eligibility is limited to reciprocal cash balances between the institution and the counterparty. Institutions may amend risk-weighted exposure amounts and, as relevant, expected loss amounts only for loans and deposits that they have received themselves and that are subject to an on-balance sheet netting agreement.

Article 196

Master netting agreements covering repurchase transactions or securities or commodities lending or borrowing transactions or other capital market-driven transactions

Institutions adopting the Financial Collateral Comprehensive Method set out in Article 223 may take into account the effects of bilateral netting contracts covering repurchase transactions, securities or commodities lending or borrowing transactions, or other capital market-driven transactions with a counterparty. Without prejudice to Article 299, the collateral taken and securities or commodities borrowed within such agreements or transactions shall comply with the eligibility requirements for collateral set out in Articles 197 and 198.

Article 197

Eligibility of collateral under all approaches and methods

Institutions may use the following items as eligible collateral under all approaches and methods:

(a) cash on deposit with, or cash assimilated instruments held by, the lending institution;

(b) debt securities, issued by central governments or central banks, which have a credit assessment by an ECAI or export credit agency where: (i) the ECAI or export credit agency has been nominated by the institution for the purposes of Chapter 2; and (ii) the credit assessment has been determined by EBA to be associated with credit quality step 1, 2, 3 or 4 under the rules for the risk weighting of exposures to central governments and central banks under Chapter 2;

(c) debt securities, issued by institutions, which have a credit assessment by an ECAI where: (i) the ECAI has been nominated by the institution for the purposes of Chapter 2; and (ii) the credit assessment has been determined by EBA to be associated with credit quality step 1, 2 or 3 under the rules for the risk weighting of exposures to institutions under Chapter 2;

(d) debt securities, issued by other entities, which have a credit assessment by an ECAI where: (i) the ECAI has been nominated by the institution for the purposes of Chapter 2; and (ii) the credit assessment has been determined by EBA to be associated with credit quality step 1, 2 or 3 under the rules for the risk weighting of exposures to corporates under Chapter 2;

(e) debt securities having a short-term credit assessment by an ECAI where: (i) the ECAI has been nominated by the institution for the purposes of Chapter 2; and (ii) the credit assessment has been determined by EBA to be associated with credit quality step 1, 2 or 3 under the rules for the risk weighting of short-term exposures under Chapter 2;

(f) equities or convertible bonds that are included in a main index;

(g) gold bullion;

(h) securitisation positions that are not resecuritisation positions and which are subject to a 100 % risk weight or lower in accordance with Article 261 to Article 264.

For the purposes of point (b) of paragraph 1, ‘debt securities issued by central governments or central banks’ shall include all the following:

(a) debt securities issued by regional governments or local authorities, exposures to which are treated as exposures to the central government in whose jurisdiction they are established under Article 115(2);

(b) debt securities issued by public sector entities which are treated as exposures to central governments in accordance with Article 116(4);

(c) debt securities issued by multilateral development banks to which a 0 % risk weight is assigned under Article 117(2);

(d) debt securities issued by international organisations which are assigned a 0 % risk weight under Article 118.

For the purposes of point (c) of paragraph 1, ‘debt securities issued by institutions’ shall include all the following:

(a) debt securities issued by regional governments or local authorities other than those debt securities referred to in point (a) of paragraph 2;

(b) debt securities issued by public sector entities, exposures to which are treated in accordance with Article 116(1) and (2);

(c) debt securities issued by multilateral development banks other than those to which a 0 % risk weight is assigned under Article 117(2).

An institution may use debt securities that are issued by other institutions or investment firms and that do not have a credit assessment by an ECAI as eligible collateral where those debt securities fulfil all the following criteria:

(a) they are listed on a recognised exchange;

(b) they qualify as senior debt;

(c) all other rated issues by the issuing institution of the same seniority have a credit assessment by an ECAI which has been determined by EBA to be associated with credit quality step 3 or above under the rules for the risk weighting of exposures to institutions or short term exposures under Chapter 2;

(d) the lending institution has no information to suggest that the issue would justify a credit assessment below that indicated in point (c);

(e) the market liquidity of the instrument is sufficient for these purposes.

Institutions may use units or shares in CIUs as eligible collateral where all the following conditions are satisfied:

(a) the units or shares have a daily public price quote;

(b) the CIUs are limited to investing in instruments that are eligible for recognition under paragraphs 1 and 4;

Where a CIU invests in shares or units of another CIU, conditions laid down in points (a) to (c) of the first subparagraph shall apply equally to any such underlying CIU.

The use by a CIU of derivative instruments to hedge permitted investments shall not prevent units or shares in that undertaking from being eligible as collateral.

For the purposes of paragraph 5 of this Article, where a CIU (the ‘original CIU’) or any of its underlying CIUs are not limited to investing in instruments that are eligible under paragraphs 1 and 4 of this Article, the following shall apply:

(a) where the institutions apply the look-through approach referred to in Article 132a(1) or Article 152(2) for direct exposures to a CIU, they may use units or shares in that CIU as collateral up to the amount equal to the value of the instruments held by that CIU that are eligible under paragraphs 1 and 4 of this Article;

(b) where institutions apply the mandate-based approach referred to in Article 132a(2) or 152(5) for direct exposures to a CIU, they may use units or shares in that CIU as collateral up to the amount equal to the value of the instruments held by that CIU that are eligible under paragraphs 1 and 4 of this Article under the assumption that that CIU or any of its underlying CIUs have invested in non-eligible instruments to the maximum extent allowed under their respective mandates.

Where any underlying CIU has underlying CIUs of its own, institutions may use units or shares in the original CIU as eligible collateral provided that they apply the methodology laid down in the first subparagraph.

Where non-eligible assets can have a negative value due to liabilities or contingent liabilities resulting from ownership, institutions shall do both of the following:

(a) calculate the total value of the non-eligible assets;

(b) where the amount obtained under point (a) is negative, subtract the absolute value of that amount from the total value of the eligible assets.

ESMA shall develop draft implementing technical standards to specify the following:

(a) the main indices referred to in point (f) of paragraph 1 of this Article, in point (a) of Article 198(1), in Article 224(1) and (4), and in point (e) of Article 299(2);

(b) the recognised exchanges referred to in point (a) of paragraph 4 of this Article, in point (a) of Article 198(1), in Article 224(1) and (4), in point (e) of Article 299(2), in point (k) of Article 400(2), in point (e) of Article 416(3), in point (c) of Article 428(1), and in point 12 of Annex III in accordance with the conditions laid down in point (72) of Article 4(1).

ESMA shall submit those draft implementing technical standards to the Commission by 31 December 2014.

Power is conferred on the Commission to adopt the implementing technical standards referred to in the first subparagraph in accordance with Article 15 of Regulation (EU) No 1095/2010.

Article 198

Additional eligibility of collateral under the Financial Collateral Comprehensive Method

In addition to the collateral established in Article 197, where an institution uses the Financial Collateral Comprehensive Method set out in Article 223, that institution may use the following items as eligible collateral:

(a) equities or convertible bonds not included in a main index but traded on a recognised exchange;

(b) units or shares in CIUs where both the following conditions are met: (i) the units or shares have a daily public price quote; (ii) the CIU is limited to investing in instruments that are eligible for recognition under Article 197(1) and (4) and the items mentioned in point (a) of this subparagraph.

In the case a CIU invests in units or shares of another CIU, conditions (a) and (b) of this paragraph equally apply to any such underlying CIU.

The use by a CIU of derivative instruments to hedge permitted investments shall not prevent units or shares in that undertaking from being eligible as collateral.

Where the CIU or any underlying CIU are not limited to investing in instruments that are eligible for recognition under Article 197(1) and (4) and in the items referred to in paragraph 1, point (a), of this Article, the following shall apply:

(a) where institutions apply the look-through approach referred to in Article 132a(1) or 152(2) for direct exposures to a CIU, they may use units or shares in that CIU as collateral up to the amount equal to the value of the instruments held by that CIU, that are eligible under Article 197(1) and (4), and the items referred to in paragraph 1, point (a), of this Article;

(b) where institutions apply the mandate-based approach referred to in Article 132a(2) or 152(5) for direct exposures to a CIUs, they may use units or shares in that CIU as collateral up to the amount equal to the value of the instruments held by that CIU, that are eligible under Article 197(1) and (4), and the items referred to in paragraph 1, point (a), of this Article under the assumption that that CIU or any of its underlying CIUs have invested in non-eligible instruments to the maximum extent allowed under their respective mandates.

Where non-eligible instruments can have a negative value due to liabilities or contingent liabilities resulting from ownership, institutions shall do both of the following:

(a) calculate the total value of the non-eligible instruments;

(b) where the amount obtained under point (a) is negative, subtract the absolute value of that amount from the total value of the eligible instruments.

Article 199

Additional eligibility for collateral under the IRB Approach

In addition to the collateral referred to in Articles 197 and 198, institutions that calculate risk-weighted exposure amounts and expected loss amounts under the IRB Approach may also use the following forms of collateral:

(a) immovable property collateral in accordance with paragraphs 2, 3 and 4;

(b) receivables in accordance with paragraph 5;

(d) leasing in accordance with paragraph 7.

Unless otherwise specified under Article 124(9), institutions may use as eligible collateral residential property which is or will be occupied or let by the owner, or the beneficial owner in the case of personal investment companies, and commercial immovable property, including offices and other commercial premises, where both of the following conditions are met:

(a) the property value does not materially depend upon the credit quality of the obligor;

(b) the risk of the borrower does not materially depend upon the performance of the underlying property or project, but on the underlying capacity of the borrower to repay the debt from other sources, and as a consequence the repayment of the facility does not materially depend on any cash flow generated by the underlying property serving as collateral.

For the purposes of the first subparagraph, point (a), institutions may exclude situations where purely macro-economic factors affect both the property value and the performance of the borrower.

Institutions may derogate from point (b) of paragraph 2 for exposures secured by residential property situated within the territory of a Member State, where the competent authority of that Member State has published evidence showing that a well-developed and long-established residential property market is present in that territory with loss rates that do not exceed any of the following limits:

(a) the aggregated amount reported by institutions under Article 430a(1), point (a), divided by the aggregated amount reported by institutions under Article 430a(1), point (c), does not exceed 0,3 %;

(b) the aggregated amount reported by institutions under Article 430a(1), point (b), divided by the aggregated amount reported by institutions under Article 430a(1), point (c), does not exceed 0,5 %.

Where either of the conditions in points (a) and (b) of the first subparagraph is not met in a given year, institutions shall not use the treatment set out in that subparagraph until both conditions are satisfied in a subsequent year.

Institutions may derogate from point (b) of paragraph 2 for commercial immovable property situated within the territory of a Member State, where the competent authority of that Member State has published evidence showing that a well-developed and long-established commercial immovable property market is present in that territory with loss rates that do not exceed any of the following limits:

(a) the aggregated amount reported by institutions under Article 430a(1), point (d), divided by the aggregated amount reported by institutions under Article 430a(1), point (f), does not exceed 0,3 %;

(b) the aggregated amount reported by institutions under Article 430a(1), point (e), divided by the aggregated amount reported by institutions under Article 430a(1), point (f), does not exceed 0,5 %.

Where a public development credit institution as defined in Article 429a(2) of this Regulation issues a promotional loan as defined in Article 429a(3) of this Regulation to another institution, or to a financial institution that is authorised to carry out activities as referred to in Annex I, point 2 or 3, to Directive 2013/36/EU and that meets the conditions set out in Article 119(5) of this Regulation, and where that other institution or financial institution passes through directly or indirectly that promotional loan to an ultimate obligor and cedes the receivable from the promotional loan as collateral to the public development credit institution, the public development credit institution may use the ceded receivable as eligible collateral, regardless of the original maturity of the ceded receivable.

Competent authorities shall permit an institution to use as eligible collateral physical collateral of a type other than those indicated in paragraphs 2, 3 and 4 where all the following conditions are met:

(a) there are liquid markets, evidenced by frequent transactions taking into account the asset type, for the disposal of the collateral in an expeditious and economically efficient manner. Institutions shall carry out the assessment of this condition periodically and where information indicates material changes in the market;

(b) there are well-established, publicly available market prices for the collateral. Institutions may consider market prices as well-established where they come from reliable sources of information such as public indices and reflect the price of the transactions under normal conditions. Institutions may consider market prices as publicly available, where these prices are disclosed, easily accessible, and obtainable regularly and without any undue administrative or financial burden;

(c) the institution analyses the market prices, time and costs required to realise the collateral and the realised proceeds from the collateral;

(d) the institution demonstrates that in at least 90 % of all liquidations for a given type of collateral the realised proceeds from the collateral are not below 70 % of the collateral value; where there is material volatility in the market prices, the institution demonstrates to the satisfaction of the competent authority that its valuation of the collateral is sufficiently conservative.

Institutions shall document the fulfilment of the conditions specified in points (a) to (d) of the first subparagraph and those specified in Article 210.

Article 200

Other funded credit protection

Institutions may use the following other funded credit protection as eligible collateral:

(a) cash on deposit with, or cash assimilated instruments held by, a third party institution in a non-custodial arrangement and pledged to the lending institution;

(b) life insurance policies pledged to the lending institution;

(c) instruments issued by a third‐party institution or by an investment firm which are to be repurchased by that institution or by that investment firm on request.

Sub-Section 2

Unfunded credit protection

Article 201

Eligibility of protection providers under all approaches

Institutions may use the following parties as eligible providers of unfunded credit protection:

(a) central governments and central banks;

(b) regional governments or local authorities;

(d) international organisations to which a 0 % risk weight is assigned in accordance with in Article 118;

(e) public sector entities, claims on which are treated in accordance with Article 116;

(f) institutions, and financial institutions for which exposures to the financial institution are treated as exposures to institutions in accordance with Article 119(5);

(fa) regulated financial sector entities;

(g) where the credit protection is not provided to a securitisation exposure, other undertakings, that have a credit assessment by a nominated ECAI, including parent undertakings, subsidiaries or affiliated entities of the obligor where a direct exposure to those parent undertakings, subsidiaries or affiliated entities has a lower risk weight than the exposure to the obligor;

(h) qualifying central counterparties.

For the purposes of the first subparagraph, point (fa), of this Article, ‘regulated financial sector entity’ means a financial sector entity meeting the condition set out in Article 142(1), point (4)(b).

Article 203

Eligibility of guarantees as unfunded credit protection

Institutions may use guarantees as eligible unfunded credit protection.

Sub-Section 3

Types of derivatives

Article 204

Eligible types of credit derivatives

Institutions may use the following types of credit derivatives, and instruments that may be composed of such credit derivatives or that are economically effectively similar, as eligible credit protection:

(a) credit default swaps;

(b) total return swaps;

Where an institution buys credit protection through a total return swap and records the net payments received on the swap as net income, but does not record the offsetting deterioration in the value of the asset that is protected either through reductions in fair value or by an addition to reserves, that credit protection does not qualify as eligible credit protection.

Where an internal hedge has been conducted in accordance with the first subparagraph and the requirements in this Chapter have been met, institutions shall apply the rules set out in Sections 4 to 6 for the calculation of risk-weighted exposure amounts and expected loss amounts where they acquire unfunded credit protection.

Article 204a

Eligible types of equity derivatives

Where an internal hedge has been conducted in accordance with the first subparagraph and the requirements in this Chapter have been met, institutions shall apply the rules set out in Sections 4 to 6 of this Chapter for the calculation of risk-weighted exposure amounts and expected loss amounts where they acquire unfunded credit protection.

Section 3

Requirements

Sub-Section 1

Funded credit protection

Article 205

Requirements for on-balance sheet netting agreements other than master netting agreements referred to in Article 206

On-balance sheet netting agreements other than master netting agreements referred to in Article 206 shall qualify as an eligible form of credit risk mitigation where all the following conditions are met:

(a) those agreements are legally effective and enforceable in all relevant jurisdictions, including in the event of the insolvency or bankruptcy of a counterparty;

(b) institutions are able to determine at any time the assets and liabilities that are subject to those agreements;

(c) institutions monitor and control the risks associated with the termination of the credit protection on an ongoing basis;

(d) institutions monitor and control the relevant exposures on a net basis and do so on an ongoing basis.

Article 206

Requirements for master netting agreements covering repurchase transactions or securities or commodities lending or borrowing transactions or other capital market driven transactions

Master netting agreements covering repurchase transactions, securities or commodities lending or borrowing transactions or other capital market driven transactions shall qualify as an eligible form of credit risk mitigation where the collateral provided under those agreements meets all the requirements laid down in Article 207(2) to (4) and where all the following conditions are met:

(a) they are legally effective and enforceable in all relevant jurisdictions, including in the event of the bankruptcy or insolvency of the counterparty;

(b) they give the non-defaulting party the right to terminate and close-out in a timely manner all transactions under the agreement upon the event of default, including in the event of the bankruptcy or insolvency of the counterparty;

(c) they provide for the netting of gains and losses on transactions closed out under an agreement so that a single net amount is owed by one party to the other.

Article 207

Requirements for financial collateral

Securities issued by the obligor, or any related group entity, shall not qualify as eligible collateral. This notwithstanding, the obligor's own issues of covered bonds falling within the terms of Article 129 qualify as eligible collateral when they are posted as collateral for a repurchase transaction, provided that they comply with the condition set out in the first subparagraph.

Institutions shall have conducted sufficient legal review confirming the enforceability of the collateral arrangements in all relevant jurisdictions. They shall re-conduct such review as necessary to ensure continuing enforceability.

Institutions shall fulfil all the following operational requirements:

(a) they shall properly document the collateral arrangements and have in place clear and robust procedures for the timely liquidation of collateral;

(b) they shall use robust procedures and processes to control risks arising from the use of collateral, including risks of failed or reduced credit protection, valuation risks, risks associated with the termination of the credit protection, concentration risk arising from the use of collateral and the interaction with the institution's overall risk profile;

(d) they shall calculate the market value of the collateral, and revalue it accordingly, at least once every six months and whenever they have reason to believe that a significant decrease in the market value of the collateral has occurred; ESG-related considerations shall prompt an assessment of whether a significant decrease in the market value of the collateral has occurred;

(e) where the collateral is held by a third party, they shall take reasonable steps to ensure that the third party segregates the collateral from its own assets;

(f) they shall ensure that they devote sufficient resources to the orderly operation of margin agreements with OTC derivatives and securities-financing counterparties, as measured by the timeliness and accuracy of their outgoing margin calls and response time to incoming margin calls;

(g) they shall have in place collateral management policies to control, monitor and report the following: (i) the risks to which margin agreements expose them; (ii) the concentration risk to particular types of collateral assets; (iii) the reuse of collateral including the potential liquidity shortfalls resulting from the reuse of collateral received from counterparties; (iv) the surrender of rights on collateral posted to counterparties.

Article 208

Requirements for immovable property collateral

The following requirements on legal certainly shall be met:

(a) a mortgage or charge is enforceable in all jurisdictions which are relevant at the time of the conclusion of the credit agreement and shall be properly filed on a timely basis;

(b) all legal requirements for establishing the pledge have been fulfilled;

(c) the protection agreement and the legal process underpinning it enable the institution to realise the value of the protection within a reasonable timeframe.

The following requirements on monitoring of property values and on property valuation shall be met:

(a) institutions monitor the value of the property on a frequent basis and at a minimum once every year for commercial immovable property and once every three years for residential property. Institutions carry out more frequent monitoring where the market is subject to significant changes in conditions;

(b) the property valuation is reviewed when information available to institutions indicates that the property value may have declined materially relative to general market prices and that review is carried out by a valuer who possesses the necessary qualifications, ability and experience to execute a valuation and who is independent from the credit decision process; ESG-related considerations, including those related to limitations imposed by the relevant Union and Member States regulatory objectives and legal acts, as well as, where relevant for internationally active institutions, third-country legal and regulatory objectives, shall be considered to be an indication that the property value might have declined materially, relative to general market prices; for loans exceeding EUR 3 million or 5 % of the own funds of an institution, the property valuation shall be reviewed by such valuer at least every three years.

Institutions may monitor the value of the immovable property and identify the immovable property in need of revaluation, in accordance with paragraph 3, by means of advanced statistical or other mathematical methods (‘models’), provided that those methods are developed independently from the credit decision process and all of the following conditions are met:

(a) the institutions set out, in their policies and procedures, the criteria for using models to monitor the values of collateral and to identify the properties that should be revaluated; those policies and procedures shall account for such models’ proven track record, property-specific variables considered, the use of minimum available and accurate information, and the models’ uncertainty;

(b) the institutions ensure that the models used are: (i) property- and location-specific at a sufficient level of granularity; (ii) valid and accurate, and subject to robust and regular back-testing against the actual observed transaction prices; (iii) based on a sufficiently large and representative sample, based on observed transaction prices; (iv) based on up-to-date data of high quality;

(d) the institutions ensure that the documentation of the models is up to date;

(e) the institutions have in place adequate IT processes, systems and capabilities and have sufficient and accurate data for any model-based monitoring of the value of immovable property collateral and identification of property in need of revaluation;

(f) the estimates of models are independently validated and the validation process is generally consistent with the principles set out in Article 185, where applicable.

By way of derogation from Article 92(5), point (a)(ii), and without prejudice to the derogation set out in Article 92(3), second subparagraph, for exposures secured by immovable property granted before 1 January 2025, institutions that apply the IRB Approach referred to in Chapter 3 of this Title by using their own estimates of LGD shall not be required to apply the provisions set out in the first subparagraph of this paragraph.

Article 209

Requirements for receivables

The following requirements on legal certainty shall be met:

(a) the legal mechanism by which the collateral is provided to a lending institution shall be robust and effective and ensure that that institution has clear rights over the collateral including the right to the proceeds from the sale of the collateral;

(b) institutions shall take all steps necessary to fulfil local requirements in respect of the enforceability of security interest. Lending institutions shall have a first priority claim over the collateral although such claims may still be subject to the claims of preferential creditors provided for in legislative provisions;

(c) institutions shall have conducted sufficient legal review confirming the enforceability of the collateral arrangements in all relevant jurisdictions;

(d) institutions shall properly document their collateral arrangements and shall have in place clear and robust procedures for the timely collection of collateral;

(e) institutions shall have in place procedures that ensure that any legal conditions required for declaring the default of a borrower and timely collection of collateral are observed;

(f) in the event of a borrower's financial distress or default, institutions shall have legal authority to sell or assign the receivables to other parties without consent of the receivables obligors.

The following requirements on risk management shall be met:

(a) an institution shall have in place a sound process for determining the credit risk associated with the receivables. Such a process shall include analyses of a borrower's business and industry and the types of customers with whom that borrower does business. Where the institution relies on its borrowers to ascertain the credit risk of the customers, the institution shall review the borrowers' credit practices to ascertain their soundness and credibility;

(b) the difference between the amount of the exposure and the value of the receivables shall reflect all appropriate factors, including the cost of collection, concentration within the receivables pool pledged by an individual borrower, and potential concentration risk within the institution's total exposures beyond that controlled by the institution's general methodology. Institutions shall maintain a continuous monitoring process appropriate to the receivables. They shall also review, on a regular basis, compliance with loan covenants, environmental restrictions, and other legal requirements;

(c) receivables pledged by a borrower shall be diversified and not be unduly correlated with that borrower. Where there is material positive correlation, institutions shall take into account the attendant risks in the setting of margins for the collateral pool as a whole;

(d) institutions shall not use receivables from affiliates of a borrower, including subsidiaries and employees, as eligible credit protection;

(e) institution shall have in place a documented process for collecting receivable payments in distressed situations. Institutions shall have in place the requisite facilities for collection even when they normally rely on their borrowers for collections.

Article 210

Requirements for other physical collateral

Physical collateral other than immovable property collateral shall qualify as eligible collateral under the IRB Approach where all the following conditions are met:

(a) the collateral arrangement under which the physical collateral is provided to an institution shall be legally effective and enforceable in all relevant jurisdictions and shall enable that institution to realise the value of the collateral within a reasonable timeframe;

(b) with the sole exception of permissible first priority claims referred to in Article 209(2)(b), only first liens on, or charges over, collateral shall qualify as eligible collateral and an institution shall have priority over all other lenders to the realised proceeds of the collateral;

(c) institutions shall monitor the value of the collateral on a frequent basis and at least once every year. Institutions shall carry out more frequent monitoring where the market is subject to significant changes in conditions;

(d) the loan agreement shall include detailed descriptions of the collateral as well as detailed specifications of the manner and frequency of revaluation;

(e) institutions shall clearly document in internal credit policies and procedures available for examination the types of physical collateral they accept and the policies and practices they have in place in respect of the appropriate amount of each type of collateral relative to the exposure amount;

(f) institutions' credit policies with regard to the transaction structure shall address the following: (i) appropriate collateral requirements relative to the exposure amount; (ii) the ability to liquidate the collateral readily; (iii) the ability to establish objectively a price or market value; (iv) the frequency with which the value can readily be obtained, including a professional appraisal or valuation; (v) the volatility or a proxy of the volatility of the value of the collateral.

(g) when conducting valuation and revaluation, institutions shall take fully into account any deterioration or obsolescence of the collateral, paying particular attention to the effects of the passage of time on fashion- or date-sensitive collateral; for physical collateral, obsolescence of collateral shall also include ESG-related valuation considerations related to prohibitions or limitations imposed by the relevant Union and Member States regulatory objectives and legal acts, as well as, where relevant for internationally active institutions, third-country legal and regulatory objectives;

(h) institutions shall have the right to physically inspect the collateral. They shall also have in place policies and procedures addressing their exercise of the right to physical inspection;

(i) the collateral taken as protection shall be adequately insured against the risk of damage and institutions shall have in place procedures to monitor this.

Where general security agreements, or other forms of floating charge, provide the lending institution with a registered claim over a company’s assets and where that claim contains both assets that are not eligible as collateral under the IRB Approach and assets that are eligible as collateral under the IRB Approach, the institution may recognise those latter assets as eligible funded credit protection. In that case, that recognition shall be conditional on those assets meeting the requirements for eligibility of collateral under the IRB Approach as set out in this Chapter.

Article 211

Requirements for treating lease exposures as collateralised

Institutions shall treat exposures arising from leasing transactions as collateralised by the type of property leased, where all the following conditions are met:

(a) the conditions set out in Article 208 or 210, as applicable, for the type of property leased to qualify as eligible collateral are met;

(b) the lessor has in place robust risk management with respect to the use to which the leased asset is put, its location, its age and the planned duration of its use, including appropriate monitoring of the value of the security;

(d) where this has not already been ascertained in calculating the LGD level, the difference between the value of the unamortised amount and the market value of the security is not so large as to overstate the credit risk mitigation attributed to the leased assets.

Article 212

Requirements for other funded credit protection

Cash on deposit with, or cash assimilated instruments held by, a third party institution shall be eligible for the treatment set out in Article 232(1), where all the following conditions are met:

(a) the borrower's claim against the third party institution is openly pledged or assigned to the lending institution and such pledge or assignment is legally effective and enforceable in all relevant jurisdictions and is unconditional and irrevocable;

(b) the third party institution is notified of the pledge or assignment;

(c) as a result of the notification, the third party institution is able to make payments solely to the lending institution or to other parties only with the lending institution's prior consent.

Life insurance policies pledged to the lending institution shall qualify as eligible collateral where all the following conditions are met:

(a) the life insurance policy is openly pledged or assigned to the lending institution;

(b) the company providing the life insurance is notified of the pledge or assignment and, as a result of the notification, may not pay amounts payable under the contract without the prior consent of the lending institution;

(c) the lending institution has the right to cancel the policy and receive the surrender value in the event of the default of the borrower;

(d) the lending institution is informed of any non-payments under the policy by the policy-holder;

(e) the credit protection is provided for the maturity of the loan. Where this is not possible because the insurance relationship ends before the loan relationship expires, the institution shall ensure that the amount deriving from the insurance contract serves the institution as security until the end of the duration of the credit agreement;

(f) the pledge or assignment is legally effective and enforceable in all jurisdictions which are relevant at the time of the conclusion of the credit agreement;

(g) the surrender value is declared by the company providing the life insurance and is non-reducible;

(h) the surrender value is to be paid by the company providing the life insurance in a timely manner upon request;

(i) the surrender value shall not be requested without the prior consent of the institution;

(j) the company providing the life insurance is subject to Directive 2009/138/EC or is subject to supervision by a competent authority of a third country which applies supervisory and regulatory arrangements at least equivalent to those applied in the Union.

Sub-Section 2

Unfunded credit protection and credit linked notes

Article 213

Requirements common to guarantees and credit derivatives

Subject to Article 214(1), credit protection deriving from a guarantee or credit derivative shall qualify as eligible unfunded credit protection where all of the following conditions are met:

(a) the credit protection is direct;

(b) the extent of the credit protection is clearly set out and incontrovertible;

(c) the credit protection contract does not contain any clause, the fulfilment of which is outside the direct control of the lending institution, that: (i) would allow the protection provider to cancel or change the credit protection unilaterally; (ii) would increase the effective cost of the credit protection as a result of a deterioration in the credit quality of the protected exposure; (iii) could prevent the protection provider from being obliged to pay out in a timely manner in the event that the original obligor fails to make any payments due, or where the leasing contract has expired for the purpose of recognising guaranteed residual value under Articles 134(7) and 166(4); (iv) could allow the maturity of the credit protection to be reduced by the protection provider;

(d) the credit protection contract is legally effective and enforceable in all jurisdictions which are relevant at the time of the conclusion of the credit agreement.

For the purposes of the first subparagraph, point (c), a clause in the credit protection contract providing that flawed due diligence or fraud by the lending institution cancels or diminishes the extent of the credit protection offered by the guarantor, shall not disqualify that credit protection from being eligible.

For the purposes of the first subparagraph, point (c), the protection provider may make one lump sum payment of all monies due under the claim, or may assume the future payment obligations of the obligor covered by the credit protection contract.

An institution shall have conducted sufficient legal review confirming the enforceability of the unfunded credit protection in all relevant jurisdictions. It shall repeat such review as necessary to ensure continuing enforceability.

Article 214

Sovereign and other public sector counter-guarantees

Institutions may treat the exposures referred to in paragraph 2 as protected by a guarantee provided by the entities listed in that paragraph, provided that all the following conditions are satisfied:

(a) the counter-guarantee covers all credit risk elements of the claim;

(b) both the original guarantee and the counter-guarantee meet the requirements for guarantees set out in Articles 213 and 215(1), except that the counter-guarantee need not be direct;

(c) the cover is robust and nothing in the historical evidence suggests that the coverage of the counter-guarantee is less than effectively equivalent to that of a direct guarantee by the entity in question.

The treatment set out in paragraph 1 shall apply to exposures protected by a guarantee which is counter-guaranteed by any of the following entities:

(a) a central government or a central bank;

(b) a regional government or a local authority;

(c) a public sector entity, claims on which are treated as claims on the central government in accordance with Article 116(4);

(d) a multilateral development bank or an international organisation, to which a 0 % risk weight is assigned under or by virtue of Articles 117(2) and 118 respectively;

(e) a public sector entity, claims on which are treated in accordance with Article 116(1) and (2).

Article 215

Additional requirements for guarantees

Guarantees shall qualify as eligible unfunded credit protection where all the conditions in Article 213 and all the following conditions are met:

(a) on the qualifying default of or non-payment by the obligor, the lending institution has the right to pursue, in a timely manner, the guarantor for any monies due under the claim in respect of which the protection is provided;

(b) the guarantee is an explicitly documented obligation assumed by the guarantor;

(c) either of the following conditions is met: (i) the guarantee covers all types of payments the obligor is expected to make in respect of the claim; (ii) 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 payment by the guarantor shall not be subject to the lending institution first having to pursue the obligor.

In the case of unfunded credit protection covering residential mortgage loans, the requirements in Article 213(1), point (c)(iii), and in the first subparagraph, point (a), of this paragraph, shall only be required to be satisfied within 24 months.

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