Calculation of expected credit losses for guaranteed exposures

We would like to know whether full substitution of the guarantor parameters to the debtor’s parameters (so that ECL are effectively calculated on the guarantor) can take place when calculating ECL on a guaranteed exposure in accordance with Regulation 2016/2067 (IFRS 9) as elaborated on by EBA Guidelines 2017/06.

We have a question on the proper calculation of Stage 1 and Stage 2 impairment for a guaranteed instrument when a bank uses an ECL model based on PD and LGD parameters. This question is especially relevant for publicly guaranteed exposures. We believe there are theoretically 2 ways of calculating the amount of ECL on a guaranteed exposure (or on the guaranteed portion of an exposure): Substitution of the parameters of the guarantor to the parameters of the debtor. This approach, mirroring what could be done under the IRB approach for the calculation of RWA, means that the ECL on an instrument are calculated using the PD and the LGD parameters of the guarantor Adjustment of the LGD of the instrument to reflect its guaranteed nature. In this case, the PD used is the parameter associated to the debtor while the LGD is either a reduced LGD of the debtor, or directly the LGD of the guarantor Banks may use a full substitution approach mirroring in accounting what they do for RWA calculation purposes. Nevertheless we believe only approach 2 is compliant with IFRS 9 in case of a post-default guarantee while approach 1 can only apply to pre-default guarantees.