Introduction to Definition of Default Rules
The Definition of Default Rules (RX) module is introduced in Temenos Transact to enable banks to meet the regulatory rules governing the identification of default of an obligor, which has a bearing in regulatory capital requirement calculations. The existing Obligor Objects (OX) module is a pre-requisite, while the Default Contagion (JX) module is optional.
This functionality is developed based on the European Banking Authority (EBA) guidelines and Regulatory Technical Standards (RTS) on the definition of default. However, the framework developed offers the flexibility to the banks in other jurisdictions as well.
The definition of default of an obligor is based on two criteria:
- Days Past Due (DPD) – An obligor is identified as default, when there is a delay in repayment beyond a certain number of days. According to the EBA guidelines, a consecutive period of 90 days for non-repayment of a material past due amount is considered as default. To determine the materiality of the past due amount, a test involving absolute and relative threshold checks are performed. If the breach of the materiality tests continues for 90 consecutive days, an obligor is considered in default based on the days past due or delay in payment.
- Unlikeliness to Pay (UTP) indicators – Refers to when banks have reasonable doubts with regards to the unlikeliness of repayment of the obligation in a timely manner. For example, non-accrued interest status or distressed restructuring are considered as UTP indicators.
Probation Period
When a defaulted obligor is eligible to move to a non-defaulted status, the probation period is applicable according to the regulatory rules. Probation period refers to the time period that an obligor is monitored for, before the defaulted obligor returns to non-default status. The probation period can vary between obligors subjected to distressed restructuring and those obligors who are not. As defined by the EBA, a period of 365 days is allotted for distressed restructuring cases and a minimum of 90 days for other cases.
The Definition of Default Rules module consists of the following features:
Obligor Classification
This feature covers the classification of an obligor as Retail and/or Non-Retail, based on the Sector defined in the CUSTOMER application. This is required to be able to apply differential treatment such as, level of application of default and level of materiality threshold values.
Days Past Due Criteria
The materiality threshold checks that are, absolute and relative threshold tests, are performed to monitor the DPD count and the eventual setting of the DPD default flag. The DPD default flag is applicable at both asset and obligor level based on the level of application of default.
Unlikeliness to Pay Indicator
Banks or financial institutions identify the UTP indicators, some of which are regulatory specified, and some additionally defined by the banks, based on which an obligor can be identified as default. The setting of these UTP indicators, at obligor level, to denote the default is a manual process, except for one UTP indicator known as the pulling effect test. Where the level of application is at the facility level and the defaulted exposure is greater than a defined percentage (EBA recommends 20%), the obligor is considered to be in default through this UTP identifier.
Default on Probation
An obligor is considered as default for as long as the institution considers it unlikely that the obligation will be paid in full without recourse to actions such as realising collateral. An obligor is monitored for a particular period before returning to non-defaulted status. The period of probation can vary based on whether distressed restructuring is extended to an obligor or not. While the recommended minimum standard probation period is 90 days, the probation period for obligors subjected to distressed restructuring is 365 days.
Default Through Contagion
The contagion process works among or between obligors. When an obligor is in default, other related obligors are also identified as default, through a defined or contractual (joint obligation) relationship. In the case of a contractual relationship (JO), a materiality threshold test is performed in the contagion process.
Illustrating Model Parameters
This section covers the following Model parameters.
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