As of January 1st, 2021, the new definition of default set out in the European Regulation on prudential requirements for credit institutions and financial intermediaries
([1]) entered into force, introducing stricter criteria than those applied so far.
The new definition of default concerns the way in which banks and financial intermediaries must classify clients for purposes of calculating their minimum capital requirements. In particular, debtors are classified as "in default" when at least one of the following conditions applies:
1.a material payment obligation is overdue for more than 90 days (180 when secured by real estate or for public entities);
2.it is unlikely (in the opinion of the bank) that the debtor will discharge its payment obligation in full without recourse to actions such as the enforcement of collateral.
Condition 2. was already in force prior to 2021. As to condition 1., an overdue payment obligation is now considered material when the amount of the arrears exceeds both of the following thresholds:
(a)EUR 100 for retail exposures and EUR 500 for non-retail exposures (absolute threshold);
(b)1 per cent of the total exposure to a counterparty (relative threshold).
If both thresholds are exceeded for more than 90 or 180 days in a row, as the case may be, the debtor is classified as in a state of default. Since January 1st, 2021, in order to avoid default, debtors are no longer allowed to set off pro-forma overdue amounts against available credit lines (so-called available margins) without actual utilisation of such credit lines.
The Bank of Italy has clarified that the new definition of default:
(i)does not change the underlying criteria for reporting non-performing loans ("crediti in sofferenza") to the Central Counterparty Risk Office, which intermediaries use in order to assess the creditworthiness of their customers;
(ii)does not introduce a prohibition for banks on allowing overdrafts in accordance with their own policies, including – at their discretion – beyond the covenanted overdraft limits.
With respect to (i), although the report of a customer as "non-performing" continues to be made on the basis of a serious and not temporary difficulty, without recourse to the new criteria for the definition of default, as from January 1st, 2021, intermediaries that are part of a banking or financial group will have to consider, in the assessment, all information, positive and negative, concerning said debtor available to the group (hence the term "group default").
([1])Article 178 of EU Regulation 575/2013, as supplemented by the EBA Guidelines on the application of the definition of default (EBA/GL/2016/07) and the Delegated Regulation (EU) No 171/2018 of the European Commission of 19 October 2017, which identifies the materiality threshold for obligations in arrears.
