EU banks’ credit risk estimates continue to fall

Mean average weighted corporate PD down to 2.24% from 2.61% in Q1 2018

European Union lenders’ probability-of-default (PD) estimates for corporate borrowers fell in Q1 2019 for the third consecutive quarter, regulatory data shows.

The mean average weighted PD for corporate exposures, as gauged by EU banks for counterparties across 39 countries, was 2.24% in Q1 2019, down from 2.26% in the previous quarter and 2.61% a year prior.

The mean average weighted loss-given-default estimate was 35.16%, down from 35.42% on the quarter and 35.28% on the year.

Corporate PDs ranged from 0.6% for Russian counterparties to 11.8% for Greek borrowers. LGD values were lowest for Danish corporates, at 22.15% and highest for Chinese companies, at 47.36%.

Credit risk estimates for retail exposures also edged lower quarter-on-quarter. The mean average weighted PD for these was 2.31% in Q1 2019, down from 3.20% three months prior. However, this was higher than the 2.04% posted in Q1 2018.

The mean average weighted LGD estimate for retail exposures was 26.28%, down from 26.91% in Q4 2018, but up from 25.49% in Q1 2018.

Swedish retail borrowers attracted the lowest average weighted PD estimates, at 0.37%, and Slovakian borrowers the highest, at 15.1%. Retail LGD values were lowest for Maltese debtors, at 9.54%, and highest for Indian debtors, at 52.08%.

What is it?

The European Banking Authority produces quarterly credit risk parameters, based on data provided by EU banks that use internal-ratings based approaches. The disclosure is intended to increase transparency on the default rate, loss rate, PD and LGD of the retail and corporate counterparties of EU banks.

PDs are computed as a weighted average of non-defaulted exposures. Only statistics for countries with more than three banks reporting in that particular country are shown.

Why it matters

Lower PDs and LGDs imply lower regulatory capital charges for credit exposures. All else being equal, therefore, the sinking default estimates mean EU banks will have to hold less cash against the loans they make to corporate and retail borrowers, bolstering their overall lending capacity. 

A question mark hangs over the veracity of these credit risk estimates, however. EU banks’ internal ratings-based approach models have come under scrutiny through the targeted review of internal models (Trim), while the EBA found that 39% of surveyed lenders had set IRB capital charges lower than the level suggested by the watchdogs’ own benchmarks.

The average weighted PDs and LGDs may shift in future quarters, therefore, for reasons besides a change in credit conditions, as banks revise their models to bring them in line with EBA and Trim standards.

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