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11
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
2
Content
Asset Segmentation
RWA calculation
RWA monitoring
3
1. Asset segmentation
4
Retail portfolio
Mortgage portfolio
Past due items
5
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
6
Allocation of each asset (transaction) to correct exposure class
Retail exposure class eligibility criteria:
• 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)
Retail portfolio (2)
7
Allocation of each asset (transaction) to correct exposure class
Retail exposure class eligibility criteria:
• 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)
Retail portfolio (3)
8
Allocation of each asset (transaction) to correct exposure class
! 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
Retail portfolio (4)
9
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.
Retail portfolio (5)
10
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
Retail portfolio (6)
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
11
Retail portfolio
Mortgage portfolio
Past due items
12
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)
13
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.
Mortgage portfolio (2)
14
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.
Mortgage portfolio (3)
15
Retail portfolio
Mortgage portfolio
Past due items
16
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
17
2. RWA calculation
18
Risk Weights
Fundamental steps
Practical examples
19
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%
20
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%
21
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
22
Risk Weights
Fundamental steps
Practical examples
23
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)
24
Guarantees (personal guarantees)
Financial collateral
Conversion of net off-balance amount
Application of corresponding RW
Fundamental steps (2)
25
Risk Weights
Fundamental steps
Practical examples
26
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
27
Risk Weight Amount calculation (2)
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
13Conversion of off-balance
facility20% 0 500 0
14Conversion of off-balance
facility50% 0 0 0
15Conversion of off-balance
facility100% 0 0 0
16Application of
corresponding RW75% 75% 35%/75%
17 RWA 712.5 772.5 582
28
Risk Weight Amount calculation (3)
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
29
Risk Weight Amount calculation (4)
No
.
Steps Mortgage Loan
fully guaranteed
by State
Mortgage Loan
partially guaranteed
by State
Car Loan
8 Provision amount On-balance 10 10 40
9 Provision amount Off-balance 0 0 0
10 Net exposure On-balance 990 990 960
11 Net exposure Off-balance 0 0 0
12Conversion of off-
balance facility0% 0 0 0
13Conversion of off-
balance facility20% 0 0 0
14Conversion of off-
balance facility50% 0 0 0
15Conversion of off-
balance facility100% 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.
30
Risk Weight Amount calculation (5)
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
31
Risk Weight Amount calculation (6)
No
.
Steps Mortgage
Loan
Mortgage Past
Due
Personal Loan
Past Due
8 Provision amount On-balance 70 840 110
9 Provision amount Off-balance 0 0 0
10 Net exposure On-balance 430 160 890
11 Net exposure Off-balance 500 0 0
12Conversion of off-
balance facility0% 0 0 0
13Conversion of off-
balance facility20% 0 0 0
14Conversion of off-
balance facility50% 500 0 0
15Conversion of off-
balance facility100% 0 0 0
16Application of
corresponding RW35%/75% 50%/100% 150%
17 RWA 326.7 130 1335
32
3. RWA monitoring
33
• 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)
34
• 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)
35
Thank you for your attention !