II. Standardised Approach for Credit Risk - Treatment of ... · 5 Allocation of each asset...

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II. Standardised Approach for Credit Risk -

Treatment of the retail portfolio and mortgage

Bogdan MOINESCU

Workshop on the Implementation of Basel II

Standardised Approaches – Practical issues

Skopje,

17 October 2011

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Content

Asset Segmentation

RWA calculation

RWA monitoring

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1. Asset segmentation

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Retail portfolio

Mortgage portfolio

Past due items

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Allocation of each asset (transaction) to correct exposure class

Retail exposure class eligibility criteria:

Retail portfolio (1)

• Debtors’ typology

(Orientation criterion):

- Private Individuals (PI)

- Small and Medium Entity

(SME)

Source: European Commission

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• Transactions are part of an homogenous portfolio (Granularity criterion)

- 2006/48/CE Directive: The exposure shall be one of a significant number of

exposures with similar characteristics such that the risks associated with such

lending are substantially reduced

- Basel II Doc.: The retail portfolio is sufficiently diversified to a degree that

reduces the risks in the portfolio (one way of achieving this may be to set a

numerical limit that no aggregate exposure to one counterpart can exceed 0.2%

of the overall retail portfolio)


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• Total exposure amount, excluding facilities collateralized by Residential

Real Estate, is less than EUR 1 mil

-2006/48/CE Directive: The total amount owed to the credit institution and

parent undertakings and its subsidiaries, including any past due exposure, by

the obligor client or group of connected clients, but excluding claims or

contingent claims secured on residential real estate collateral, shall not, to the

knowledge of the credit institution, exceed EUR 1 million.

- The credit institution shall take reasonable steps to acquire this

knowledge.

-Basel II Doc.: Total exposure is calculated considering also the exposure of the

group of connected clients to the credit institution and parent undertakings and

its subsidiaries (including leasing companies)


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! Basel II text book includes an additional eligibility criterion:

• Types of products (Product criterion)

-revolving credits and lines of credit (including credit cards and overdrafts),

personal term loans and leases (e.g. installment loans, auto loans and leases,

student and educational loans, personal finance) and small business facilities

and commitments

- Securities (such as bonds and equities), whether listed or not, are specifically

excluded from this category


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Allocation of facilities to Retail exposure class is defined internally by each

credit institution.

• breaches of the EUR 1 mil. threshold could be allowed under specified

conditions, on a temporary basis, considering fluctuations of:

- exchange rates (relevant for CHF or JPY loans)

- interest rate, including penalty charges, a.s.o

• credit institutions can be conservative when defining SMEs, considering:

- a turnover level lower than that already established by domestic commercial

legislation.


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Segmentation must revised at least once

a year.

In case no additional facilities are granted,

criteria fulfillment check should be

performed for:

- non-revolving loans: against remaining

outstanding amounts;

- revolving loans: against latest approved

limits

Reclassifications of assets from retail to

non-retail are, usually, sticky.

- conservative approach to be used when

the exposure class could be changed


EUR:CHF=1.20 EUR:CHF=1.25

Exposure class:

Non-retail

Loan to Mr. X

Outstanding

amount:

CHF 1.25 mil.

~ EUR 1.04 mil

Loan to Mr. X

Outstanding

amount:

CHF 1.2 mil.

~ EUR 0.96 mil

Exposure class:

Non-retail

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Retail portfolio

Mortgage portfolio

Past due items

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Exposure class

Mortgage exposure class:

1. Exposures secured by Real Estate:

• Value of the property is not materially dependant on the credit

quality of the obligor

- the debtor has not a dominant share in the relevant market

• Risk of the debtor is not dependant on the performance of the

underlying property

- e.g. rent < 15% of income

• Value of the property exceeds the exposure with a substantial

margin

- e.g. LTV<75%

• Real estate satisfies specific collateral requirements

Mortgage portfolio (1)

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Real Estate collateral requirements

• Legal certainty: meant to ensure the realization of the value of the protection

within a reasonable timeframe;

• Monitoring: regular monitoring and revaluation of the property, at minimum

once every three years for residential real estate and once a year for

commercial real estate. In times of significant market changes, more frequent

monitoring is mandatory;

• Documentation: clear documentation and registration of the collateral in

internal systems is mandatory;

• Insurance: credit institution need to have internal processes monitoring

property insurances.


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Real Estate collateral requirements

In case the collateral does not meet previous mentioned eligibility

criteria, it cannot be taken into consideration when segmenting the

exposure.

Under these circumstances, the exposure will be regarded as fully

unsecured and segmented accordingly.


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Retail portfolio

Mortgage portfolio

Past due items

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Exposure class

Past Due Exposures:

• Exposure that are past due for more than 90 days and which is

above a threshold defined by local regulators.

- materiality issue

o absolute value (e.g. EUR 10)

o ratio of outstanding amount (e.g. 0.5%)

Past Due Items

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2. RWA calculation

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Risk Weights

Fundamental steps

Practical examples

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Risk Weights (1)

Exposure class and Risk Weight

Different Risk Weights (RW) are applied to each exposure class, therefore, the

importance of correct allocation of each transaction) to exposure class.

Item

no.Exposure class Detail RW

1. Retail 75%

2.Mortgage - Residential

Real Estate

The fully secured part

(including the

significant margin)

35%

3.Mortgage - Residential

Real Estate

The unsecured part

(exceeding the

significant margin)

75%

4.Mortgage - Commercial

Real EstateThe fully secured part 50%

5.Mortgage - Commercial

Real EstateThe unsecured part 100%

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Risk Weights (2)

Exposure class and Risk Weight

For Past Due Items, provision amount is important, as it indicates that part of the

loss for the respective facility has already been taken covered.

Item

no.Exposure class Detail RW

6. Past Due ItemsUnsecured & provision

ratio >= 20%100%

7. Past Due ItemsUnsecured & provision

ratio < 20%150%

8. Past Due ItemsSecured & provision

ratio >= 20%50%

9. Past Due ItemsSecured & provision

ratio < 20%100%

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Risk Weights (3)

Credit conversion factors

•0% for low risk facilities

• undrawn credit facilities with an original maturity of up to and including one

year which may be cancelled unconditionally at any time without notice or

that effectively provide for automatic cancellation due to deterioration in a

borrower's creditworthiness

•20% for medium/low risk facilities

• undrawn credit facilities with an original maturity of up to and including one

year which may not be cancelled unconditionally at any time without notice or

that do not effectively provide for automatic cancellation due to deterioration

in a borrower's creditworthiness

•50% for medium risk facilities

• undrawn credit facilities with an original maturity of more than one year

•100% for full risk facilities

• irrevocable standby letters of credit having the character of credit

substitutes, credit derivatives

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Risk Weights

Fundamental steps

Practical examples

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Gross exposure amount:

• On-balance

• Off-balance

Exposure split

• Secured amount

• Unsecured amount

Provision amount

• On-balance

• Off-balance

Exposure amount net of provision

Fundamental steps (1)

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Guarantees (personal guarantees)

Financial collateral

Conversion of net off-balance amount

Application of corresponding RW

Fundamental steps (2)

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Risk Weights

Fundamental steps

Practical examples

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Risk Weight Amount calculation (1)

No. Steps Personal Loan Overdraft

facility

Mortgage Loan

1Gross exposure

amount

On-balance1000 1000 1000

2Gross exposure

amount

Off-balance0 500 0

3

RE Collateral

Value

(SM=33.3%)

-

0 0 500

4Personal

Guarantee0 0 0

5Financial

collateral0 0 0

6Secured

amount

-0 0 375

7Unsecured

amount

-1000 1500 625

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No

.

Steps Personal Loan Overdraft

facility

Mortgage

Loan

8 Provision amount On-balance 50 70 30

9 Provision amount Off-balance 0 0 0

10 Net exposure On-balance 950 930 970

11 Net exposure Off-balance 0 500 0

12Conversion of off-balance

facility0% 0 0 0


facility20% 0 500 0


facility50% 0 0 0


facility100% 0 0 0

16Application of

corresponding RW75% 75% 35%/75%

17 RWA 712.5 772.5 582

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No. Steps Mortgage Loan

fully guaranteed

by State

Mortgage Loan

partially guaranteed

by State

Car loan

1Gross exposure

amount

On-balance1000 1000 1000

2Gross exposure

amount

Off-balance0 0 0

3

RE Collateral

Value

(SM=33.3%)

-

0 500 0

4Personal

Guarantee1000 500 0

5Financial

collateral0 0 200

6Secured

amount (RE)

-0 375 0

7Unsecured

amount

-1000 625 1000

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No

.

Steps Mortgage Loan

fully guaranteed

by State

Mortgage Loan

partially guaranteed

by State

Car Loan





12Conversion of off-

balance facility0% 0 0 0







16Application of

corresponding RW0%* 0%/35%/75% 75%

17 RWA 0 217.75 570

* for personal guarantees, the RW applicable to the Sovereign guarantor is applied and is

reported accordingly by Outflow to corresponding Non-retail report.

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No. Steps Mortgage Loan Mortgage Past Due Personal Loan

Past Due

1Gross exposure

amount

On-balance500 1000 1000

2Gross exposure

amount

Off-balance500 0 0

3

RE Collateral

Value

(SM=33.3%)

-2000 (10%

pledged)500 0

4Personal

Guarantee0 0 0

5Financial

collateral100 0 0

6Secured

amount RE

-150 375 0

7Unsecured

amount

-850 625 1000

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No

.

Steps Mortgage

Loan

Mortgage Past

Due

Personal Loan

Past Due













16Application of

corresponding RW35%/75% 50%/100% 150%

17 RWA 326.7 130 1335

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3. RWA monitoring

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• key risk factors that have an adverse effect on RWA amount

• special focus on secured exposure class, since they are subject to more

regulatory requirements

• real estate regular monitoring must be ensured, since any collateral

that has not been re-valued during the past year could be subject to

severe depreciation

• enhance lending standards (credit risk policies) as to ensure that the

value of the property exceeds the exposures by a substantial margin (e.g

LTV<75%)

• ensure the update of client income information, related to the

correlation between rent (of the mortgaged property) and his other types

of income

• The risk of the borrower must not materially depend upon the performance of

the underlying property.

RWA monitoring (1)

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• key risk factors that have an adverse effect on RWA amount

• special focus on secured exposure class, since they are subject to more

regulatory requirements

• real estate property insurance must be valid

o regular processes for identifying expired insurances

o determining the proper solution

C&B analysis for portfolio collateral insurance

inclusion in collection processes (in case of overdue clients)

credit institution pays itself the insurance premium for each new client

• special focus on zero CF

• review conditions for revolving facilities as to ensure that they are

commitments unconditionally cancellable at any time by the bank without

prior notice

• effectively provide for automatic cancellation due to deterioration in a

borrower’s creditworthiness

RWA monitoring (2)

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Thank you for your attention !

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