EBA Guidelines on loan origination and monitoring

On 22 December 2022, the CSSF published its Circular 22/824 which implements the requirements of the European Banking Authority guidelines on loan origination and monitoring.

The European Banking Authority (EBA) guidelines on loan origination and monitoring (the Guidelines) were originally published by the EBA on 29 May 2020 as part of the Council of the European Union’s Action Plan on tackling non-performing exposures. The aim of the Guidelines is to ensure that that newly originated loans are of a sound credit quality and do not turn into non-performing loans throughout their life cycle.

The Circular and rules under the Guidelines will apply from 31 March 2023.

In scope entities

The Guidelines are applicable in their entirety to the following entities:

• Luxembourg credit institutions that are less significant institutions, on an individual, sub-consolidated and consolidated basis; and
• Luxembourg branches of credit institutions having their registered office in a third country.

Only section 5 (Loan origination procedures) and Section 6 (Pricing) of the Guidelines are applicable to the following entities:

• Professionals performing lending operations under Article 28-4 of the law of 5 April 1993 on the financial sector; and
• Luxembourg creditors within the meaning of the mortgage credit directive¹ and the consumer credit directive².

Only consumer protection-related provisions of the Guidelines apply to Luxembourg credit institutions that are significant institutions and Luxembourg branches of EU credit institutions.

In scope transactions

The Guidelines are applicable in their entirety to credit facilities granted by in-scope entities.

Only Section 5 (Loan origination procedures) and Section 6 (Pricing) of the Guidelines apply to loan and advances³ including credit for consumption, mortgage loans, credit card debt, revolving loans and overdrafts, syndicated loans, financial leases and trade loans granted by in-scope entities:

• which are originated after 31 March 2023; or
• that already existed on 30 June 2021 if their terms and conditions are changed after 31 March 2023 and provided that such changes follow a specific credit decision approval, and if their implementation requires a new loan agreement with the borrower or an addendum to the existing agreement.

The Guidelines are not applicable to the following transactions:

• Loans and advances to credit institutions, investment firms, financial institutions, insurance and reinsurance undertakings, central banks and sovereigns, including central governments, regional and local authorities, public sector entities; and
• Derivatives, debt securities and securities financing transactions by in-scope entities.

Requirements regarding internal governance for credit granting and monitoring

The Guidelines set out certain requirements regarding internal governance for credit granting and monitoring, in particular:

• the responsibilities of the management body;

• the definition and implementation of a credit risk culture;
• the definition and implementation of the credit risk appetite, strategy and credit risk limits;
• the content of the credit risk policies and procedures, including:
  • the content of AML/CFT policies and procedures;
  • the definition of leveraged transactions at the level of the institution (taking into consideration the level of leverage of the borrower and the purpose of the transaction);
  • specific requirements for the use of technology-enabled innovation for credit-granting purposes;
  • specific requirements for the use of automated models for creditworthiness assessment and credit decision-making;
  • incorporation of ESG factors and associated risks in the credit risk appetite and risk management policies and credit risk policies and procedures;
  • specific requirements for institutions that originate or plan to originate environmentally sustainable credit facilities;
  • requirement for institutions’ data infrastructure and security of information;

• the establishment of a clear and well-documented credit decision-making framework, including:
  • requirements to ensure that decisions taken by credit decision-makers are impartial, objective and not adversely affected by any conflict of interest;
  • inclusion of the principles of accountability, segregation and independence of functions and responsibilities, challenge and assurance of outcomes in the internal control framework;
• ensuring that institutions have sufficient resources and staff allocated to credit risk taking and, in particular, credit decision-making, credit risk management and internal control; and
• ensuring that institutions’ remuneration policies and practices are in line with their approach to credit risk management, credit risk appetite and strategies, and do not create a conflict of interest.

Loan originations procedures

The Guidelines sets out certain requirements regarding loan origination, in particular:

• the information and data necessary to assess the borrower’s creditworthiness and risk profile before concluding a loan agreement;

• the information and data necessary for the creditworthiness assessment of consumers;

• the requirements for assessing borrowers’ creditworthiness, including:
  • specific requirements for the assessment of consumers’ creditworthiness and when:
    • lending to consumers in relation to residential immovable property;
    • lending to consumers in relation to other immovable property;
    • lending to consumers without taking security;
  • specific requirements for lending to micro and small enterprises, for lending to SMEs, for commercial real estate lending, for real estate development lending, for leveraged transactions, for shipping finance and for project finance; and

• the set-up of documentation regarding credit decisions and loan agreements allowing for reliable and accurate creditworthiness assessment.

Pricing

The Guidelines set out certain requirements regarding the pricing frameworks of institutions, in particular:

• taking into account of the institution’s credit risk appetite and business strategies in the pricing framework;

• taking into account of the characteristics of the loan product, competition and prevailing market conditions for loan pricing;

• definition of the institutions pricing based on type of borrower and type of loans;

• specific requirements for governance structures in relation to pricing;

• requirement for the documentation of the pricing framework; and

• requirement for monitoring of profitability, pricing and costs.

Valuation of immovable and movable property

The Guidelines set out certain requirements regarding the valuation of immovable and movable property for credit facility secured by an immovable or movable property collateral, in particular:

• the requirements for the valuation at origination and internal policies and procedures for valuation of collateral;

• the requirements for the monitoring and revaluation of property and content of internal policies for revaluation of collateral;

• the requirements for the valuer carrying out the valuation or revaluation tasks including on skills and experience, independence, remuneration, performance and conflict of interest;

• the requirements for the use of advanced statistical models for the purposes of valuation, revaluation and monitoring the values of collateral.

Monitoring framework

The Guidelines sets out certain requirements regarding the monitoring framework of institutions and the data infrastructure to support this monitoring. In particular:

• the data infrastructure should ensure that information regarding credit risk exposures, borrowers and collateral is relevant and up to date, and that the external reporting is reliable, complete, up to date and timely;

• specific requirements for monitoring of credit exposures and borrowers;

• specific requirements for the regular credit review of borrowers to identifying any changes in their risk profile, financial position or creditworthiness;

• the monitoring and follow up on covenants included in credit agreement; and

• development of early warning indicators, supported by an appropriate IT and data infrastructure, to allow for the timely detection of credit risk in the institution’s portfolio including appropriate follow up process further to the triggering of and early warning indicator.

Proportionality

When implementing the Guidelines, in-scope entities should take implementing measures that are proportionate to their size and their internal organisation as well as to the nature, scale and complexity of their activities or services (including their risks).

Application and next steps

The Circular will apply from 31 March 2023. Credit institutions and professionals of the financial sector will need to assess the impact of the Guidelines and adapt or adopt internal policies and procedures in line with these rules.

^{1 Directive 2014/17/EU of the European Parliament and of the Council of 4 February 2014 on credit agreements for consumers relating to residential immovable property} .
^{2 Directive 2008/48/EC of the European Parliament and of the Council of 23 April 2008 on credit agreements for consumers.
3 As defined in Annex V of Commission Implementing Regulation (EU) 2021/451 of 17 December 2020 laying down implementing technical standards for the application of Regulation (EU) No 575/2013 of the European Parliament and of the Council with regard to supervisory reporting of institutions and repealing Implementing Regulation (EU) No 680/2014.}