Effect on the capital requirement of a guarantee where the right to call is linked to default versus another where it is linked to realised loss

Question

Let’s take a portfolio level guarantee that is callable once losses from the exposures covered have been realised (and NOT when exposures DEFAULT); realised losses decrease the notional of the guarantee. As it can take years till losses get realised after the default event, while losses are still unrealised (but defaults have happened) the full notional is used to cover the whole portfolio. Our question is whether such a guarantee is eligible to be taken into account as unfunded credit protection and thus decrease the capital requirement of the sub-portfolio it cover?

European Banking Authority · Accepted Answer

Under Article 215 of Regulation (EU) No. 575/2013 (CRR), a guarantee may only qualify as eligible unfunded credit protection where all of the conditions set out in that article and all of the conditions in Article 213 are met.  If, by the terms of the guarantee, the lending institution does not have the right to pursue the guarantor for any monies due but unpaid until such time as losses from the guaranteed exposures have been realised (the timing of which is indeterminate), neither the conditions of Article 215(1)(a) nor Article 213(1)(c) of the CRR, particularly point (iii), would be met.

Effect on the capital requirement of a guarantee where the right to call is linked to default versus another where it is linked to realised loss

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