Need for correction in the adoption of the new definition of default by FIN-FSA-supervised banks applying the Standardised Approach

In winter 2022–2023, the Financial Supervisory Authority (FIN-FSA) conducted a thematic review of the adoption of the new definition of default (DoD) by banks under its direct supervision that apply the Standardised Approach for capital requirements calculation.

Differences were identified across the banks in terms of compliance with regulation concerning the definition of default. The most significant shortcomings were found in the classification of non-performing forborne exposures as defaulted, in the definition of past due exposures and in the calculation of the diminished financial obligation in the event of distressed restructuring.

The following shortcomings were identified in the thematic review:

Past due criteria

• The decisive criterion in the definition of a past due exposure is a single payment being more than 90 days past due.
• The materiality thresholds for past due credit obligations have not been set at the levels required by regulation.

Indications of unlikeliness to pay (UTP) and their assessment

• The diminished financial obligation is not calculated in the event of distressed restructuring, or the calculation is not made using the customer’s original effective interest rate.
• No external sources of data are used in the identification of default.
• The indications of unlikeliness to pay have not been defined comprehensively, including distressed restructuring events.
• Only delinquencies of 90 days past due have led to the classification as defaulted, i.e. defaulted exposures have not been identified through UTP indications.

Definitions and criteria of curing

• The probation period of curing has not been defined for other circumstances than distressed restructuring.
• The consideration of the obligor’s payment behaviour and financial situation during the probation period as well as the assessment of the factuality of curing are inadequate.
• The starting point and the length of the probation period as well as the curing criteria in the event of distressed restructuring differ from regulatory requirements.
• Monitoring of the effectiveness of practices related to curing is defective.

In addition, shortcomings were identified in:

• Rules of contagion of default
• Moments of assessment of default
• Classification of non-performing forborne exposures as defaulted
• Identification of technical past due situations
• Definitions of non-performing, defaulted and impaired (IFRS 9 stage 3) exposures and differences between them.

The FIN-FSA will review the findings on a bank-specific basis and require entities under its supervision to remediate the identified shortcomings. In addition, the FIN-FSA will monitor the progress of the remediation measures in its ongoing supervision and inspections.

A thematic review refers to a survey on a supervision topic addressed at several target entities to form an assessment, based on the responses, of the practices applied by the entities. These reviews generate comparable and consistent information from several target entities at the same time. Thematic reviews also provide the FIN-FSA with information on deviations concerning individual target entities, which may be used as signals for upcoming inspections or other supervisory actions.

For further information, please contact

• Torsten Groschup, Senior Risk Expert, telephone +358 9 183 5333 or torsten.groschup(at)fiva.fi
• Mikael Jämsä, Banking Supervisor, telephone +358 9 183 5282 or mikael.jamsa(at)fiva.fi