The Use of IFRS for Prudential and Regulatory Purposes Alignment of capital, regulatory, and accounting requirements

Transcription

1 The Use of IFRS for Prudential and Regulatory Purposes Alignment of capital, regulatory, and accounting requirements REPARIS IFRS Seminar Vienna, May

2 Introduction Basel II and IFRS - What is at stake?» Alignment of capital management, regulatory and accounting requirements» System and process requirements (portfolio segmentation, rating systems, statistical models) Use of Basel II data for loan loss provisioning possible or even required? 1

3 Introduction Basel II and IFRS -Two different approaches Two different objectives Two different philosophies Basel II Ensure the bank has sufficient provisions or capital to support its expected losses over the course of the next 12 months IFRS Ensure that the financial statements adequately reflect the losses that have been incurred at the balance sheet date Basel II Expected loss model (IRB approach) IFRS Incurred loss model 2

4 Introduction Basel II and IFRS Key interfaces Similarities exist but also differences Definition of defaulted versus impaired Expected versus incurred loss model Segmentation of the loan portfolio LGD versus impairment loss Certain disclosure and data requirements Other differences (day one losses, treatment of derivatives, disclosures) 3

5 Basel II credit risk requirements Three approaches to Credit Risk Increasing sophistication with more advanced qualitative criteria Standardised Approach Successor to 1988 Basel Capital Accord with some additional risk sensitivity through use of wider range of risk weights linked to external credit ratings. Foundation Internal Ratings Approach Institution s portfolio is split by broad category of exposure; Institutions assign ratings linked to probability of default (PD). Other inputs are set by the supervisor. Advanced Internal Ratings Approach As for the Foundation Approach, but in addition to calculating PD, institutions also use their own estimates of loss given default (LGD) and of exposure at default (EAD). 4

6 Basel II credit risk requirements Portfolio Categorisation Sovereigns Banks Corporates Specialised lending Sovereigns, central banks, MDBs Other public agencies (if accepted) Banks Security firms Corporate debt Redemption primarily using company cash-flow Specialised lending Redemption by object revenues/cash-flow RWSM Foundation Approach Advanced Approach Purchased receivables Purchased receivables Bottom up/ Top down Purchased receivables Bottom up/ Top down Retail SMEs (max. 1 mill. EUR) Private individuals Residential Mortgage Overdrafts / credit cards Other retail Retail approach Equities Equity Other participation rights MTM - PD/LGD 5

7 Basel II credit risk requirements Basel II Expected loss Product Workout Costs Rating Customer Segment Limit Utilisation Collateral Value Collateral Type Expected Loss Probability of Default (PD) Exposure at Default (EAD) = x x Loss given default (LGD) What is the probability that a counterparty will default? What will be our exposure at this point in time? How much of this are we likely to lose? Counterparty Specific Transaction Specific 6

8 Basel II credit risk requirements Definition of Default A default is considered to have occurred when any of the following events has taken place The bank considers that the obligor is unlikely to pay its credit obligations to the banking group in full, without recourse by the bank to actions such as realising security (if held) The obligor is past due more than 90 days on any material credit obligation to the banking group. Overdrafts will be considered as being past due once the customer has breached an advised limit or been advised of a limit smaller than current outstandings 7

9 Basel II credit risk requirements Loss Given Default (LGD) definition» Loss in the definition of LGD is defined as economic loss» Basel definition of LGD is wider than that used by many banks in the past in their internal credit risk models» Primary determinant of LGD is type of collateral and the recovery rate achieved on collateral, which affects the amount of principal lost» Basel (in line with best practice methodology) also requires banks to include other factors in the determination of LGD: Material discount effects resulting from time lag between default and ultimate recovery of funds; Material direct and indirect costs associated with collecting on the defaulted exposure (e.g. legal fees, cost of workout department, etc...)» LGD is very bank-specific measure, as it is affected by: Legal environment (affecting both legal cost and time to recovery) Efficiency of recovery process General cost base of the organisation 8

10 Basel II credit risk requirements Exposure at Default / EAD» Exposures are generally measured as the amount legally owed to the bank» For off-balance sheet exposures, credit conversion factors (CCFs) need to be applied to the exposure to obtain credit equivalent amounts» Under the foundation IRB approach, these CCFs are specified by the supervisor Commitments, Note issuance facilities and revolving underwriting facilities: CCF = 75%; Commitments that are unconditionally cancellable: CCF = 0%; Short-term, self-liquidating trade letter of credit: CCF = 20%.» Under the Advanced IRB approach, banks will be allowed to use their own estimates of EAD for products not subject to a 100% CCF under the foundation approach (e.g. securities lending or borrowing) 9

11 IFRS Loan Loss Provisioning Overview of different types of provisions Significant loans Not-significant loans choice Individual loan assessment (specific provision) Present value of future cashflows Calculate unwinding for each single loan Stop regular interest accrual impairment trigger event yes no Assessment for impairment on a portfolio basis considering the loss identification period (LIP) (portfolio allowance for non-impaired loans) Exposure x PD x LGD x LIP No unwinding, as long as it is not material (audit decision required) Continue to accrue interest on a regular basis (contractually agreed interest) no impairment trigger event yes Collective loan assessment (portfolio provision for insignificant loans) EXP x PD x LGD Calculate unwinding on a portfolio basis Stop regular interest accrual Acknowledgement of impairment requires specific provisioning if loan is significant impairment trigger event Even acknowledgement of impairment does not require specific provisioning if loan is not significant, but loan may be transferred to different sub-portfolio 10

12 IFRS Loan Loss Provisioning Trigger events and losses Definition in IAS 39.59» A financial asset or a group of financial assets is impaired..., if there is objective evidence of impairment as a result of one or more events that occurred after the initial recognition of the asset (a loss event ) and that loss event has an impact on the estimated future cash flows of the financial asset or group of financial assets that can be reliably estimated. Incurred loss model (No day 1-provisions) 11

13 IFRS Loan Loss Provisioning Implementation of impairment policy» Definition to be adopted has to be client-specific» Determination of specific indicators (trigger events)» Suggested approach: Adopting an impairment policy, fulfilling the IFRS- and Basel II-requirements Same meaning of the definition Indicators just give examples» No guidance for trigger events, because they depend on the specific circumstances of each client and his credit business 12

14 IFRS Loan Loss Provisioning Calculating Specific allowances Requirement in IAS 39.63, 64» Significant loans with trigger event» Regarding each loan on a standalone basis» Allowance calculated on the basis of present value of future cash flows» Restructuring of loans Impaired loans: restructuring causes use of specific allowance Distinction to renegotiation (without trigger event) necessary 13