Related provisions for IFPRU 4.7.15
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Where a firm adjusts assumed house price values within its LGD models to take account of current market conditions (for example, appropriate house price indices), the FCA recognises that realised falls in market values may be captured automatically. A firm adopting such approaches may remove observed house price falls from its downturn house price adjustment so as not to double count. A firm wishing to apply such an approach must seek the consent of the FCA and be able to demonstrate
The FCA uses a framework for assessing the conservatism of a firm's wholesale LGD models for which there are a low number of defaults. This framework is set out in IFPRU 4 Annex 2G (Wholesale LGD and EAD framework) and does not apply to sovereign LGD estimates which are floored at 45%. This framework is also in the process of being used to assess the calibration of a firm's material LGD-models for low-default portfolios.
The FCA expects that, as most models of this type will be able to produce one-year estimates of PD that correspond closely to point-in-time estimates, firms should conduct robust back-testing of such estimates by comparing them with realised default rates. Firms would need to demonstrate that the results of such back-testing meet pre-defined and stringent standards in order for the FCA to be satisfied that the IRB requirements are met.
To achieve a soundness standard comparable to those under the IRB approach, LGD estimates should reflect the economic cycle. Therefore, the FCA expects a firm to incorporate dependence of the recovery rate on the economic cycle into the IRC model. Should the firm use a conservative parameterisation to comply with the IRB standard of the use of downturn estimates, evidence of this should be submitted in quarterly reporting to the FCA, bearing in mind that for trading portfolios,