CRR III – New regulations for off-balance sheet items

Less CCF in the IRBA: Own estimate only for revolving exposures

The revision of the Capital Requirements Regulation (CRR III)¹ has been in force since January 1, 2025. There is no transitional provision for the newly inserted paragraph 8b in Article 166: This restricts the application of conversion factor (CCF) models to revolving exposures. What does this mean?

Off-balance sheet commitments

For contractual commitments such as loan agreements with delayed and gradual disbursement, IRBA institutions, which are allowed to estimate not only the probability of default (PD), but also credit conversion factor (CCF) and loss given default (LGD) themselves, typically use their own CCF models. CCF models forecast the proportion of the committed amount that will be released to the customer in the event of default. Particularly in the retail business, LGD and CCF must always be estimated by the institution itself.

Experience shows that CCF models for non-revolving contractual commitments are based on a small number of data points, as the observed receivables that form the development data for such models must have both defaulted and previously had an open commitment. Due to the model uncertainties resulting from small numbers of exposures, the supervisory authority has so far often insisted on the fall-back solution of applying a uniform constant CCF of 100 %, although the observed values are significantly lower on average.

CCF models only for revolving receivables

For IRBA institutions that previously estimated the CCF for non-revolving exposures themselves, the CRR refers to the “SA-CCF”, i.e. the standardized approach for determining the CCF, which results in a uniform CCF of 40 % for these commitments.

CCF models are still provided for revolving commitments, i.e. open portions of credit lines, credit card limits and overdraft facilities on current accounts.

Effects of CRR III on non-retail CCF models in the IRBA

Paragraph 8 of Article 151 also no longer provides for a separate LGD estimate for these segments. For the corporate exposure class in particular, this means that the previous application of internal CCF models will no longer apply to exposures to large companies from January 2025. If the CCF for non-revolving contractual commitments can no longer be estimated using an internal model, the scope of application of an existing CCF model may have become very small. What consequences can an IRBA institution draw?

If, for example, there has been a model for the CCF of corporate receivables up to now that only treats revolving receivables as a special case, the new regulations remove the basis for this model, as the separate CCF estimate is no longer required for non-revolving receivables and receivables from large companies. Depending on the significance and size of the remaining revolving portion of corporate exposures, switching to the F-IRBA may be considered, either for the entire corporate exposure class or only with the “type of exposure” of revolving corporate receivables.

An obligation to uniformly apply the A-IRBA with its own estimate of LGD and CCF for all exposure classes in the IRBA cannot be derived from the CRR (see also Article 151 (8) and (9)). Rather, Article 149 (2) already stipulates that it is possible to switch from the A-IRBA back to the F-IRBA with predefined CCF (and LGD) values for individual exposure classes or exposure types (in accordance with Article 142 (2)) if the relevant conditions are met.

Standardized approach: 40 % CCF for contractual commitments and 10 % CCF for open limits

In accordance with CRR III Annex I, contractual commitments are no longer differentiated by maturity, but fall under Bucket 3, which, in conjunction with Art. 111 (2), now leads to a uniform CFF of 40 % for non-cancellable contractual commitments. If one compares this with the previous maturity-dependent mix of 20 % for maturities up to 12 months and 50 % for maturities longer than 12 months, there is generally an increase for non-cancellable contractual commitments as well.

Unused limits and limits for revolving receivables can generally be terminated at any time and do not have to be backed by own funds at all under the previous regulation in the credit risk standardized approach (CRSA). This will change from 2030, when the transitional provision (CRR Article 495d) increases the CCF for commitments that can be terminated at any time to 10 % by 2033. This eliminates one advantage of the CRSA over the IRBA, particularly in the retail business, and the amount of limits and credit lines will become an aspect relevant to the institutions’ own funds.

Impact and conclusion

For institutions that estimate the CCF themselves in the IRBA, CRR III will result in some changes. The discontinuation of the use of CCF models for contractual commitments for non-revolving exposures will generally have a positive effect, not only due to a (slight) reduction in capital requirements, but also due to the elimination of expenses for model maintenance and validation.

The changes to the SA-CCF have an increasing effect on the capital requirements. After the end of the transition phase, open limits and frameworks will require capital backing, which can be quite significant in the retail business and for specialized institutions, and will also have an impact on IRBA institutions due to the output floor. We therefore expect active limit management – using ML or AI methods, for example – to become the market standard.

msg for banking is your experienced partner for a wide range of ICAAP and IRBA projects. As the effects of new regulatory requirements must also be taken into account in capital planning, every institution should promptly determine the capital requirements for the coming years, taking into account CRR III and its transitional provisions, and assess the effects of the new rules – a good opportunity to calculate alternative approaches.