NATIONAL BANK OF ROMANIA REGULATION No.26 from 15.12.2009 on the implementation, validation and assessment of Internal Ratings Based Approaches for credit institutions Having regard to the provisions of Articles 130-134, Articles 384 and 385 of the Government Emergency Ordinance no.99/2006 on credit institutions and capital adequacy, approved as further amended and supplemented by Law no.227/2007, as subsequently amended and supplemented, and those of Article 3 of the Regulation of National Bank of Romania and National Securities Commission no.15/20/2006 on credit risk treatment using the internal ratings based approach, for credit institutions and investment firms, approved by Order of National Bank of Romania and National Securities Commission no.12/109/2006, as subsequently amended and supplemented, In virtue of the provisions of Article 420 paragraph (1) of the Government Emergency Ordinance no.99/2006, approved as further amended and supplemented by Law no.227/2007, as subsequently amended and supplemented, and of Article 48 of the Law no.312/2004 regarding the National Bank of Romania Statute, National Bank of Romania issues the present regulation. CHAPTER I General Provisions
Art.1 (1) The present regulation establishes the rules regarding the implementation, validation and assessment of internal ratings based approaches. (2) The present regulation applies to credit institutions, Romanian legal persons, and to branches of third countries credit institutions established in Romania. (3) The central bodies are responsible for regulating the general framework for implementing, validating and assessing the internal ratings based approaches for credit co-operatives within the co-operative networks. The issued norms shall take into account the provisions of this regulation concerning the implementation, validation and assessment of internal ratings based approaches for credit cooperatives and shall not establish less restrictive requirements than those referred to in this regulation. Within this meaning, the regulations issued by the central body shall be transmitted for approval to the National Bank of Romania. (4) The present regulation applies at the individual level and, as the case may be, at the consolidated level, in accordance with Regulation of National Bank of Romania and National Securities Commission no.17/22//2006 regarding the consolidated supervision of credit institutions and investment firms, approved by Order of National Bank of Romania and National Securities Commission no.14/111/2006. (5) Without prejudice to paragraph (4), in the case of the applications for obtaining the permission to use the internal models for the calculation of the capital requirements, stated in the conditions set out in Article 182(1) or in Article 193(1) of the Government Emergency Ordinance no.99/2006, approved as further amended and supplemented by Law no.227/2007, as subsequently amended and supplemented, and in the case that the National Bank of Romania is not the authority responsible for consolidated supervision, the credit institutions, Romanian legal persons, are exempted, if it is not decided otherwise by/together with the other competent authorities, from the application of the provisions of Chapter II as well as of the provisions of Article 16, Article 18(4), Article 19(2) and (3), Article 21, Article 23(2), (3) and (4), Article 26, Article 31, Article 32, Article 58, Article 59(1) to (3) and (5) and Article 67(3) and Article 205(1) and (3). (6) The central bodies are responsible for applying this regulation at the level of credit co-operative network. 2
Art.2 (1) The terms and expressions used within this regulation are those defined in the Government Emergency Ordinance no.99/2006, approved as further amended and supplemented by Law no.227/2007, as subsequently amended and supplemented. (2) The terms and expressions external credit assessment institution, small and medium size entities, collective investment undertaking (CIU) and corporates have the meaning provisioned by the Regulation of National Bank of Romania and National Securities Commission no.14/19/2006 on the credit risk treatment using the standardised approach, for credit institutions and investment, approved by Order of National Bank of Romania and National Securities Commission no.11/108/2006, hereinafter referred to as Regulation NBR-NSC no.14/19/2006, as subsequently supplemented. (3) The term securitisation has the meaning provisioned by the Regulation of National Bank of Romania and National Securities Commission no.21/26/2006 on credit risk treatment regarding securitised exposures and securitisation positions, approved by Order of National Bank of Romania and National Securities Commission no.18/115/2006, hereinafter referred to as Regulation NBR-NSC no.21/26/2006. (4) The expression group of connected clients has the meaning provisioned by the Regulation of National Bank of Romania and National Securities Commission no.16/21/2006 regarding large exposures of credit institutions and investment firms, approved by Order of National Bank of Romania and National Securities Commission no.13/110/2006. (5) The term institutions has the meaning provisioned by the Regulation of National Bank of Romania and National Securities Commission no.13/18/2006 concerning the determination of minimum capital requirements for credit institutions and investment firms, approved by Order of National Bank of Romania and National Securities Commission no.10/107/2006, hereinafter referred to as Regulation NBR-NSC no.13/18/2006. (6) The expression credit risk mitigation technique has the meaning provisioned by the Regulation of National Bank of Romania and National Securities Commission no.19/24/2006 on credit risk mitigation techniques used by credit institutions and investment firms, approved by Order of National Bank of Romania and National 3
Securities Commission no.16/113/2006, hereinafter referred to as Regulation NBR-NSC no.19/24/2006. (7) The expression trading book has the meaning provisioned by the Regulation of National Bank of Romania and National Securities Commission no.22/27/2006 regarding the capital adequacy of credit institutions and investment firms, approved by Order of National Bank of Romania and National Securities Commission no.19/116/2006. (8) The expressions dilution risk, probability of default, loss, loss given default, conversion factor, expected loss, documentation, exposure, rating system, obligor grade, facility grade, foundation internal ratings based approach, advanced internal ratings based approach have the meaning provisioned by the Regulation of National Bank of Romania and National Securities Commission no.15/20/2006 on credit risk treatment using the internal ratings based approach, for credit institutions and investment firms, approved by Order of National Bank of Romania and National Securities Commission no.12/109/2006, hereinafter referred to as Regulation NBR-NSC no.15/20/2006, as subsequently amended and supplemented. (9) The expressions management body, supervisory function, management function internal control, medium level managers have the meaning provisioned by National Bank of Romania Regulation no.18/2009 on governance arrangements of the credit institutions, internal capital adequacy assessment process and the conditions for outsourcing their activities. (10) For the purpose of the present regulation the terms and expressions have the following meaning: 1. external vendor model is a model or parts of a model used by a credit institution and developed by an independent external third party that uses certain inputs to assign exposures to certain rating grades or pools or to estimate certain risk parmeters. 2. business unit represents an entity technically, geographically or organizationally separated from other parts of the credit institutions or of the group such as separate legal or organizational entities, business lines or homogeneous groups of exposures within a credit institution or a group. CHAPTER II 4
Application Section 1 Minimum content Art.3 In order to obtain approval from National Bank of Romania to apply for the use of internal ratings based approach in order to calculate the risk-weighted exposure amounts, the credit institution shall provide an overview of the internal models that the credit institution/ institutions uses/ use or plans/ plan to use and how they will be implemented in the credit institution s/ the institutions policies and procedures, and detailed information on the construction and calibration of the models, the database, the technological environment, related policies and procedures, including the credit institution s/ the institutions control environment. Art.4 (1) In the meaning of Article 3, the credit institution shall submit to the National Bank of Romania, besides the cover letter requesting approval, a documentation that contains at least the following: a) documentation of used or planned rating systems (including used models); b) documentation of the control environment of the rating systems, implementation procedures, and IT infrastructure; c) implementation plan including the Roll-Out and details on permanent partial use; d) documentation regarding the self-assessment, along with an internal audit report concerning the compliance with the requirements of Section 6 of this chapter. (2) The documentation mentioned in paragraph (1) is considered to be supporting material and shall be, unless otherwise indicated, general information regarding the implementation of the chosen internal ratings based approach. (3) The documentation mentioned in paragraph (1) shall provide a summary of the credit institution s/ the institutions current and planned practices in sufficient depth to enable the National Bank of Romania to make an initial assessment of its/ their application and to develop a risk-based plan for a more thorough assessment. 5
Section 2 Cover letter Art.5 The cover letter shall state that the credit institution/ the institutions applies, respectively jointly apply, for the approval to use, for calculating the risk-weighted exposure amounts, the chosen internal ratings based approach, taking into consideration the details provided in the attached documentation. Section 3 Documentation of rating systems Art.6 The documentation of rating systems shall include at least the following: a) a list of all internal documents held by the credit institution/ the institutions underlying its/ their validation process and that it/ they considers/ consider relevant to the application, including a brief description of their contents; b) a map of the models that the credit institution/ the institutions will use for each portfolio i.e., a statement that explains which exposures, legal entities, and geographical locations are covered or will be covered by each rating system ; c) a general description of each of the models this can include a description of the types of data used, the definitions, classifications and the methodologies used, and some quantitative and qualitative assessments ; d) a documentation that includes the information set out in Chapter V, Section 1, Subsection 1.6 Documentation of rating systems of the Regulation NBR-NSC no.15/20/2006, as subsequently amended and supplemented, and of the Article 170 of the same regulation, covering the following areas: d1) the design and operational details of the rating systems; d2) the major changes in the risk rating process; d3) the definitions of default and loss; d4) the documentation of the statistical models and other mechanical methods in compliance with Article 128 requirements; d5) the use of the external vendor models; 6
d6) the differences, if any, between the parameters used for the calculation of regulatory capital requirements and those used for internal purposes; e) a brief description of the approach to credit risk stress testing how the requirements of Chapter V, Section 1, Subsection 1.8 Stress tests used in assessment of capital adequacy of the regulation mentioned at letter d) are met, particularly the design of the stress test set out at. Article 157 of the same regulation and the potential impact over the total capital requirements for credit risk ; f) as the case may be, the documentation that contains the information regarding the aspects listed in Article117(1); g) the reporting forms specified in Article 32(2). Art.7 The credit institution shall submit to the National Bank of Romania any additional information regarding the rating systems, requested by it either in the initial application or at a later stage. Section 4 Control Environment Art.8 (1) The documentation of the control environment, implementation procedures, and the IT infrastructure shall include, as a minimum: a) an overview of the internal governance of the credit institution/ the institutions i.e., the role and responsibilities of management body, the functions of committees involved in governance, and the role and the independence of the credit risk control function and the role of Internal Audit, to the extent that these information have not been reported to the Supervision Department of the National Bank of Romania according to the provisions of the National Bank of Romania Regulation no.18/2009; b) the planned use of the different rating systems how, in practical terms, the credit institution/ the institutions plans/ plan to use different models in its/ their operating activity, respectively the documentation stipulated in Article 31; 7
c) how the experience test set out in Article 4 of the Regulation NBR-NSC no.15/20/2006, as subsequently amended and supplemented, is met and, as the case may be, how the experience test from Article 5 of the mentioned regulation is met; d) the documentation regarding the data quality standards, specified in Article 141; e) the ratings assignment process, including the documentation that contains the information set out in Article136(1) of the regulation mentioned in letter c) and the frequency with which the output of the grades and pools assignment process is actually overridden; f) the responsibilities of the parties involved in modeling; g) an overview of the validation process of rating systems, together with the documentation set out in Chapter V, Section 3 Validation of own estimates of Regulation NBR-NSC no.15/20/2006, as subsequently amended and supplemented; h) general information regarding the IT structure of the credit institution/ the institutions, to the extent that they concern the internal ratings based approach; i) as the case may be, the Internal Audit s reports. (2) The credit institution shall submit to the National Bank of Romania any additional documentation regarding the implementation of the rating systems, requested by it after the application was remitted. Section 5 Implementation plan Art.9 (1) The credit institution shall prepare a meaningful implementation plan that covers the period of time prior to approval and the roll-out period respectively, the implementation after the initial approval has been granted and to submit it to the National Bank of Romania as part of the application pack. (2) The implementation plan is a commitment on the part of the credit institution/ the institutions to implement the internal ratings based approach on the specified dates, for all of the rating systems for which it/they is/are seeking approval to use the internal ratings based approach. 8
(3) The implementation plan including roll-out shall be broken down at least by supervisory exposures classes, business units, and, if applicable, by any internal ratings based parameters that need to be estimated. The credit institution shall lay down internal rules with detailed provisions regarding time and content for combinations of the above, in particular for the following: a) development of the rating methodology; b) preparation of the technical concept for IT implementation of the rating methodology; c) IT implementation; d) training of staff, including management body s staff; e) transition from the existing rating system to the new system on the basis of current business, if a transition is made; f) formal internal acceptance of the new rating system and implementation as the rating system of the credit institution/ the institutions. (4) In the case of the applications for obtaining the permission to use the internal models for the calculation of the capital requirements submitted jointly by several institutions, the credit institution shall ensure that the provisions of paragraph (3) are applied accordingly by the other institutions of its group and together with it request approval. (5) The credit institution shall provide a list of all portfolios which are to be permanently exempted from internal ratings based approach. The exempted portfolios shall be quantified comprehensively e.g., number of material counterparties, the aggregate value of the exposures and the risk-weighted exposure amounts, calculated according to the requirements of Regulation NBR-NSC no.14/19/2006, as subsequently supplemented. Section 6 Self assessment Art.10 (1) The credit institution shall carry out a self-assessment of its/their state of readiness based on the standards and minimum requirements set out in Regulation NBR- NSC no.15/20/2006, as subsequently amended and supplemented. (2) The credit institution shall develop an action plan to fill identified gaps and deficiencies, and a schedule for achieving compliance. 9
(3) In the case of the applications for obtaining the permission to use the internal models for the calculation of the capital requirements submitted jointly by several institutions, the credit institution shall ensure that the provisions of paragraph (1) and (2) are applied accordingly by the other institutions of its group and together with it request approval. Art.11 (1) The self-assessment shall begin with a global assessment, from a consolidated perspective, of how the various models fit together within the credit institution/ the institutions or the group, global assessment which shall cover the suitability of the organizational structure in terms of internal governance, the adequacy of resources devoted to the rating system, comparability across the group with respect to data and methodology, and consistency in IT organization. (2) The self-assessment shall also cover all the aspects of the rating system: methodology, quality of data, quantitative and qualitative validation procedures, internal governance, and technological environment. (3) The self-assessment could be conducted by staff from an independent risk assessment function with the support, if necessary, of internal auditors. (4) The documentation regarding the self-assessment shall include a description of the self-assessment process undertaken, of the identified gaps and deficiencies, including an indication of the credit institution/ the institutions view of their materiality, the action plan to fill identified gaps and deficiencies, and the schedule for achieving compliance. Section 7 Other aspects regarding the cover letter Art.12 (1) The cover letter shall be signed by an executive member of the management body of each of the legal entities that apply for approval, member that has the authority to legally commit the entity. (2) The signatory or, as appropriate, the signatories shall confirm in the cover letter that the material attached to the application is a true and fair summary of the subjects covered. Summary means that the material attached to the application provides only a short presentation of the main aspects of the topic in question, true means that the 10
information contained in the summary is not false or misleading, and fair means that the information presents a reasonable overall summary, without omitting material facts. Art.13 (1) The cover letter shall be in Romanian language. (2) The attached documentation shall be in a language or languages agreed between the National Bank of Romania, the host country supervisors and the credit institution/ the institutions. For the documents written in a foreign language the certified translation in Romanian shall be also submitted. For the documents written in an international language the National Bank of Romania may exempt, on a case by case basis, the requirement regarding the certified translation. Art.14 (1) If the credit institution does not provide to the National Bank of Romania the documentation specified in Article 4 when submitting the cover letter requesting approval or at a later stage, or in case the cover letter requesting approval and/or the supporting material submitted to it by the credit institution do not comply with the requirements of Articles 3 9, Article 11(4), Article 12 and Article 13 of this regulation, the National Bank of Romania will consider the application of the credit institution/ the institutions incomplete. (2) The National Bank of Romania and, where appropriate, the other competent authorities involved perform a preliminary assessment of the entire application respectively, cover letter and supporting documentation immediately upon receipt by it. The National Bank of Romania notify the credit institution/ the institutions regarding the completeness of application. Art.15 (1) In case of cover letters formulated under the conditions provided in Article 182(1) or Article 193(1) from the Government Emergency Ordinance no.99/2006 approved as further amended and supplemented by Law no.227/2007, as subsequently amended and supplemented, and when the National Bank of Romania is the authority responsible for consolidated supervision, the six-month period set out in Article 183(3) and in Article 193(3) of the mentioned ordinance, starts as soon as the National Bank of 11
Romania receives an application i.e. the cover letter requesting approval and the supporting material that is complete with respect to this regulation. (2) The National Bank of Romania confirms the starting of the six-month period. CHAPTER III Standards for meeting the minimum requirements set out in Regulation NBR-NSC no.15/20/2006, as subsequently amended and supplemented Section 1 Permanent partial use and roll-out 1.1 Roll-out Art.16 At the moment the application for approval to use the internal ratings based approach is submitted to the National Bank of Romania, the credit institutions shall have been covered through this approach at least 50% of both the total exposure values and of the total risk-weighted exposure values. The calculation is made under the provisions of Regulation NBR-NSC no. 14/19/2006, as subsequently supplemented, for the exposures covered by the standardised approach, respectively under the provisions of Regulation NBR-NSC no.15/20/2006, as subsequently amended and supplemented, for the exposures covered by the internal ratings based approach. For the calculation of the coverage ratio, the specialised lending treated under the provisions of Article 36 of Regulation NBR-NSC no.15/20/2006, as subsequently amended and supplemented, may be considered by the credit institution as exposures under the proposed internal ratings based approach. Art.17 If the credit institutions decide to apply the roll-out of the internal ratings based approach, they shall elaborate a credible and feasible implementation plan with regard to initial coverage of the exposures the coverage at the moment of obtaining the National Bank of Romania s approval to use the respective approach and the pace of roll-out. 12
Art.18 (1) The credit institution s roll-out policy shall indicate at least the time horizon during the roll-out is realized and the roll-out sequence. (2) Establishing the time horizon for the roll-out shall take into consideration the credit institution s realistic ability to convert to the internal ratings based approach and the coverage by this approach, as soon as possible, of the credit institution s core business and main credit risk drivers. (3) The time horizon shall be short enough to avoid prolonging internal ratings based approach application unduly, and long enough to ensure the quality of data, methodology and output. (4) The roll-out shall be completed in five years from obtaining the approval to use the proposed internal rating based approach, irrespective of the type of internal ratings based approach that the credit institution wishes to implement. Art.19 (1) The sequence of exposure classes in the roll-out of the internal ratings based approach shall be based on the importance of portfolios the more important portfolios, respectively, the portfolios that represent the credit institution s core businesses, shall be rolled out first. (2) The sequence of exposure classes in the roll-out of the internal ratings based approach is chosen by the credit institution. (3) As each credit institution s portfolio is roll-out, according to the attached documentation of the cover letter requesting approval, it is not necessary that the credit institution issues a new application, excepting the cases set out in Article 23. Art.20 Before rolling out exposure classes in the internal ratings based approach, the credit institutions shall carry out a self-assessment against the requirements set out in Regulation NBR-NSC no.15/20/2006, as subsequently amended and supplemented. Art.21 (1) During the roll-out period, the credit institutions may by required on caseby-case basis: a) to notify the National Bank of Romania in regard of their plans and developments in their risk measurement and management practices; 13
b) to notify the National Bank of Romania on a timely basis when, according to the rollout plan, they are ready to use a rating system for the calculation of the regulatory capital requirements for an additional exposure class or business unit; c) to notify the National Bank of Romania on a timely basis of their intention to roll out to an exposure class. The credit institutions may additionally be required to receive explicit permission from the National Bank of Romania before starting to use the rating system for this exposure class; or d) to comply with a combination of the requirements set out in letters a), b), c). (2) For the purposes of paragraph (1), the National Bank of Romania will specify in the document by which the decision regarding the application is communicated, the requirements set out in the mentioned paragraph that the credit institution shall comply with. Art.22 Changes in the roll-out plan may be allowed when significant business environment changes take place, such as changes in strategy as a result of changes in shareholders or management body, or from a new business orientation -, mergers and acquisitions, and the mentioned changes are well justified by the credit institution. Art.23 (1) In the meaning of Article 22, in case of a change in strategy, unless there is good reason for delay, the time horizon for roll-out shall remain the same, but the roll-out sequence can change. (2) In the meaning of Article 22, where an internal ratings based approach credit institution acquires a non-internal ratings based approach credit institution, the credit institution that uses the internal ratings based approach may by asked by the National Bank of Romania, on a case by case basis, to submit a new approval application, with a new partial use and roll-out policy, or it may by asked by the National Bank of Romania to submit a plan for bringing the entire credit institution into compliance with the Regulation NBR-NSC no.15/20/2006, as subsequently amended and supplemented. (3) In the meaning of Article 22, where a non-internal ratings based approach credit institution acquires an internal ratings based approach credit institution, the National 14
Bank of Romania will ask the acquiring credit institution, if it wishes to use the internal ratings based approach, to make new approval application. (4) The provisions of paragraphs (2) and (3) apply mutatis mutandis when the credit institution was involved in a merger. Art.24 Where a credit institution planning to roll out the advanced internal ratings based approach in two steps i.e., moving first from the standardised approach to the foundation internal ratings based approach, and subsequently from the foundation internal ratings based approach to the advanced internal ratings based approach the rules and criteria of the roll-out plans apply for each step. 1.2 Permanent partial use Art.25 (1) For the purposes of Article 30(1) of Regulation NBR-NSC no.15/20/2006, as subsequently amended and supplemented, in order to obtain the approval to permanently exempt from applying the internal ratings based approach certain exposures, the credit institutions shall justify that exemptions. (2) In the meaning of paragraph (1), the reasons why the credit institution requires the exemption shall be fully set out and credible. For the purposes of Article 30(1) letters a) and b) of the regulation mentioned in paragraph (1), the justification shall explain the reasons why the credit institution feels that, in the case of exposure classes for which exemption is required, the implementation of a rating system is unduly burdensome for the credit institution, how the respective exposures fit its business and strategy, and whether the exposures fit the scope of its core activities. (3) In the presentation of the rationale for applying for exemption, the credit institutions may not justify the unduly burdensome to implement a rating system exclusively on the basis of the absence of default data, but the respective burdensome shall be evidenced also through some elements such as the comparisons with the business and strategy of the credit institution. 15
Art.26 (1) The exemption of exposures in business units, set out in Article 30(1) letter c) of Regulation NBR-NSC no.15/20/2006, as subsequently amended and supplemented, may be permitted by National Bank of Romania, subject to compliance with the provisions of paragraphs (2) (6), in case of non-significant business units for which the rating systems of the credit institution or group are not meaningful, the development of own rating systems is impossible or for which the implementation of such systems would be unduly burdensome. (2) The aggregate value of exposures permanently exempted, according to Article 30(1) of the regulation mentioned in the first paragraph, from applying the internal ratings based approach shall not exceed 10% of the total on- and off-balance sheet exposures, and the aggregate value of these exposures, measured as risk-weighted exposure amounts, shall not exceed 10% of the total risk-weighted on- and off-balance sheet exposures amounts. The calculation is made under the provisions of Regulation NBR- NSC no.14/19/2006, as subsequently supplemented, for the exposures covered by the standardised approach, respectively under the provisions of Regulation NBR-NSC no.15/20/2006, as subsequently amended and supplemented, for the exposures covered by the internal ratings based approach. (3) In the meaning of paragraph (2), the materiality thresholds stipulated in the mentioned paragraph shall be applied exclusively at the level of the credit institution or group that has requested approval for using the internal ratings based approach. (4) In order to calculate the materiality thresholds mentioned in paragraph (2), it shall not be taken into account from both the numerator and the denominator of the materiality thresholds the exposures for which the credit institutions plans to use permanent partial use based on those exposures compliance with the criteria stipulated in Article 30(1) of the regulation specified in paragraph (1), others than the criteria related to immateriality, mentioned in Article 30(1) letter c) of that regulation. (5) The credit institution or group which applied for approval to use the internal ratings based approach is responsible for monitoring compliance with the materiality thresholds mentioned in paragraph (2) and shall have in place systems and procedures that monitor materiality issues in a timely and appropriate manner. If materiality thresholds are exceeded, the credit institution/ group shall notify the National Bank of Romania and 16
shall present for approval an appropriate remedial action plan over a reasonably short timeframe. In cases where materiality thresholds are breached deliberately - for example, following a strategic decision to expand in a particular sector prior to actual expansion, the credit institution/ group shall have in place a roll-out policy. (6) The credit institution/ group shall verify compliance with the materiality thresholds mentioned in paragraph (2) at least once a year and whenever there are significant changes in its structure, for example as a result of mergers or acquisitions. Section 2 Use test 2.1 Scope Art.27 In order to obtain approval to use the internal ratings based approach, the credit institution shall demonstrate to the National Bank of Romania that the information used in or produced by its rating system to determine regulatory capital requirements is also used in the course of conducting its regular business, particularly in risk management. Art.28 Rating systems, ratings, and default and loss estimates designed and set up with the exclusive aim of receiving approval for using the internal ratings based approach, and used only to produce the data necessary for that approach, are not allowed. Art.29 (1) The credit institutions shall make effective use of internal ratings and the resulting risk parameters. If not all, at least an effective and material part of the processes and functions listed in Article 3(2) letter b) of Regulation NBR-NSC no.15/20/2006, as subsequently amended and supplemented, shall be based solely on ratings and risk parameter estimates used in calculating capital requirements, so that these ratings and risk parameter estimates have a substantial influence on the credit institutions decisionmaking and actions. (2) In the meaning of paragraph (1), the credit institutions shall ensure that the use of the mentioned data is not marginal, and shall assess the validity of differences between these 17
data and the data used for internal purposes, such as the differences between a pricing probability of default and the rating probability of default. Art.30 (1) For the purposes of Article 3(2) letter b) of Regulation NBR-NSC no.15/20/2006, as subsequently amended and supplemented, by playing an essential role it must not be meant that the data/ parameters used in calculating capital requirements have to be identical to, or a linear and homothetic function of the data used for credit management, but it must be meant that there is a strong relationship between these two data categories. (2) The credit institutions shall demonstrate that the ratings and estimates used in calculating capital requirements play an essential role in the processes and functions listed in Article 3(2) letter b) of regulation mentioned in paragraph 1 and they shall indicate where different final parameters are used internally, in compliance with the provisions of Article 170 of the respective regulation. Art.31 For assessing the impact on their operations, the credit institutions shall provide to the National Bank of Romania a documentation in which they identify and describe the use they make of internal ratings, relevant risk parameters, and all related systems and processes. Such documentation shall be updated regularly for example, by the credit risk control function and reviewed by internal audit. Art.32 (1) In order to obtain the initial permission for the use of the internal ratings based approach, and subsequently for receiving permission to use additional approaches, methods, or rating systems, the credit institutions shall report to the National Bank of Romania their total capital requirements calculed based on all the approaches, methods, or rating systems that the respective credit institution intends to use at the moment of requesting permission. (2) In the meaning of paragraph (1), the credit institutions have to fill in and submit to the National Bank of Romania upon request the reporting forms stipulated in Article 8 of National Bank of Romania Order regarding the reporting of minim capital requirements 18
for credit institutions, as subsequently amended and supplemented, and the forms CR EQU IRB and CR SEC IRB of the mentioned order. 2.2 Use of data for internal purposes Art.33 The use for internal purposes of the data used in calculating capital requirements shall be as comprehensive as necessary to ensure that those data play an essential role in the processes and functions listed in Article 3(2) letter b) of Regulation NBR-NSC no.15/20/2006, as subsequently amended and supplemented. Art.34 The data categories shall be distinguished for example, inputs in the form of data published in financial statements have to be distinguished from estimated data which result from the credit institution s calculations. All of the risk parameters estimates shall start with inputs, and those inputs should be essentially the same, whether used for credit management purposes or for regulatory capital requirement calculation purposes. Art.35 The structure and design of the rating systems and capital calculation systems shall not be fundamentally different, whatever the purpose internal or regulatory. Art.36 (1) Any differences between the ratings and risk parameter estimates used in calculating capital requirements and the final parameters used internally shall rely on a well documented rationale. The credit institution shall have in place robust audit trails, adhering to a specified internal policy, which purpose is to assess the materiality of differences and whether they lead to conservatism or relaxation in capital adequacy. (2) When pricing margins are calculated using non internal ratings based approach data, the credit institution shall sort out both types of margins calculations and include conservatism in the calculation of the regulatory capital requirements. (3) The more numerous the differences between the regulatory and the internal systems, the higher the internal governance standards have to be. 19
Art.37 For the purpose of the use test, the credit institutions using economic capital models shall provide explanations about differences in the data and parameters used in the economic capital model and those used to calculate regulatory capital requirements. Art.38 In areas relating to the credit risk assessment process such as ratings the final parameters used for internal purposes and the data used in calculating capital requirements have to be in line, but some flexibility is allowed for pricing and internal capital allocation. The final estimates for default or loss internally used shall not render the estimate used in the calculation of capital requirements implausible. Art.39 The inputs identified as major for credit risk selection, estimation, and/or management for internal purposes shall not be set aside for assigning ratings and estimating risk parameters used in the calculation of capital requirements. The source of information and related analysis shall not be missing from the criteria used for regulatory rating and probability of default estimation purposes. Art.40 The developed rating models shall be consistent with the credit institution's strategy and technology plans. The modelling and risk parameter estimates shall be as accurate as possible, reflecting the different types of exposures in portfolios and subportfolios. In cases where the credit institution have to develop various rating systems, the use test shall be applied accordingly. Art.41 In case of using of master scales for internal risk management, thus ensuring equivalent risk categories across portfolios, the credit institutions shall pay special attention to the correct calibration of each individual rating system compared to their link to the common master scale. Art.42 (1) The strategic plans of the credit institution shall provide for extensive training to help the credit institution s personnel, including the bodies having management function, understand the credit institution s rating models. The complexity 20
of the models, the internal and external processes used by the credit institution to operate the models, and how the ratings produced shall be used, need to be well understood. (2) In the context of the models effective operation, the credit institutions shall have in place a strategic plan for coordinating the human and technological resources, that has to take into account the impact of the model on the various functional areas of the credit institution. Art.43 Prior to implementation of an internal ratings based approach for a particular type of exposure, the credit institutions shall ensure a good mix between scope, experience test mentioned in Article 4 and 5 of Regulation NBR-NSC no.15/20/2006, as subsequently amended and supplemented, and internal use of data. Section 3 Methodology and documentation 3.1 Assignment to exposure classes 3.1.1 Retail exposure class 3.1.1.1 Individual persons and small and medium sized entities Art.44 (1) In order to comply with the requirements provided in Article 16 (1) letter a) of Regulation NBR-NSC no.15/20/2006, as subsequently amended and supplemented, the credit institutions shall have internal criteria for distinguishing individual persons from small and medium sized entities. (2) If an entity is separately incorporated, this aspect has to be seen as strong evidence that the entity is to be regarded as an small and medium sized entity. (3) In the meaning of paragraph (1), internal criteria used by the credit institutions can depend on how the credit institution manages its loans portfolio for example, if the credit institution manages its retail exposures on a transaction basis, the criterion shall be the purpose of the loan, and in this case, only loans to natural persons for non- 21
commercial purposes shall be regarded as exposures to individual persons; if the credit institution manages its retail exposures on an obligor basis, it needs a consistent rule on how to distinguish clients, such as: to classify a client as an small and medium sized entity if the majority of his or her income is generated by self-employment, to treat any entity that is not incorporated as an individual person. Art.45 When exceeding the EUR 1 million threshold provided in Article 16 (1) letter a) of Regulation NBR-NSC no.15/20/2006, as subsequently amended and supplemented, the exposure shall be reclassified in corporate exposure class, and for calculating the capital requirement it shall be used the corporate risk weight curve. If the rating system applied to the retail exposure class fulfils the requirements for rating systems in the corporate exposure class, no change in the rating system is required. Otherwise, the rating system for corporate exposures shall be applied. Art.46 The credit institutions shall have to be able to identify and consolidate groups of connected clients and to aggregate relevant exposures of each group of connected clients. The identification and aggregation of amounts owed by an obligor client or by a group of connected clients need to be performed across all entities of the banking group, unless explicitly excluded by Article 16(1) letter a) of Regulation NBR-NSC no.15/20/2006, as subsequently amended and supplemented. Art.47 When the total amount owed calculated in the conditions provided in Article 16(1) letter a) of Regulation NBR-NSC no.15/20/2006, as subsequently amended and supplemented, is reduced e.g. amortised and is less than EUR 1 million threshold, no automatic assignment to the retail exposure class shall be applied by the credit institution, which shall verify first the compliance with the requirements of Article 16(1) letters b)-d) of the mentioned regulation. Art.48 If a parent credit institution has subsidiaries that are direct creditors to a group of connected clients, the banking group shall have in place a process that will allow 22
proper assignment of these connected clients to the retail or to the corporate exposure class, based on the aggregate exposure. Art.49 (1) For the purposes of Article 16(1) letter c) of Regulation NBR-NSC no.15/20/2006, as subsequently amended and supplemented, the credit institutions shall demonstrate that the exposures in the retail exposure class are treated differently meaning less individually than exposures in the corporate exposure class. (2) In the meaning of paragraph (1), the credit process can be divided into the following components: marketing and sales activities, rating process, rating system, credit decision, credit risk mitigation methods, monitoring, early warning systems, and workout/recovery process. The requirement mentioned in the first paragraph can be regarded as met as long as a credit institution can demonstrate that any of these components differ clearly. The differences in the rating systems and in the recovery process used by the credit institution can provide strong evidence that the criterion set out in Article 16(1) letter c) of the regulation mentioned in the first paragraph is fulfilled. (3) Syndicated loans shall not be treated as retail exposures. (4) The credit institutions shall not adapt their risk management processes to a lower standard in order to fulfill the criterion set out in Article 16 (1) letter c) of the regulation mentioned in paragraph (1). The credit institution shall not change the treatment of an exposure in preparation for the internal ratings based approach. Art.50 (1) If the rating system is the same for the retail exposures as for corporate exposures, the credit institution shall make possible the validation of the rating system for exposures treated as retail on a stand-alone basis. The parameter estimates and capital requirement calculations for retail exposures may also be derived on a pooled basis and not only on the individual parameter estimates for individual obligors in the corporate exposure class. (2) The fact that a retail customer is assigned an individual rating shall not by itself exclude classification of that exposure as belonging to the retail sector. 3.1.1.2 Qualifying revolving retail exposures 23
Art.51 For the purposes of Article 43(2) letter b) of Regulation NBR-NSC no.15/20/2006, as subsequently amended and supplemented, the loans in the qualifying revolving retail exposure class may be secured by a general lien, that is contractually part of various exposures on the same obligor, as long as the individual exposure is treated as unsecured for capital calculation purposes i.e., recoveries from collateral may not be taken into account in estimating loss given default. Art.52 For the purposes of Article 43(2) letter b) of Regulation NBR-NSC no.15/20/2006, as subsequently amended and supplemented, an undrawn credit line is considered immediately cancellable even if consumer protection or related legislation prohibit the credit institution from cancelling it immediately or set minimum cancellation periods. Compliance with consumer protection regulation shall not prevent credit institutions from classifying exposures that comply with all other criteria as qualifying revolving retail exposures. Art.53 The threshold set out in Article 43(2) letter c) of Regulation NBR-NSC no.15/20/2006, as subsequently amended and supplemented, may be applied at the level of the credit institution. Subclasses within the qualifying revolving retail exposure class such as credit cards, overdrafts, and others shall be differentiated if their loss rates differ significantly. Art.54 (1) The demonstration of the low volatility of loss rates mentioned in Article 43(2) letter c) of Regulation NBR-NSC no.15/20/2006, as subsequently amended and supplemented, shall be made in the course of the internal ratings based approval process, and afterwards at any time upon National Bank of Romania request. (2) In order to assess the volatility of loss rates of the qualifying revolving retail exposure portfolio or sub portfolios relative to the average level of loss rates, the benchmark level shall in general be the relative volatility of loss rates of other sub portfolios in the other retail exposure category, in which the credit institution holds exposures. In this case, the 24
credit institutions shall provide data on the mean and standard deviation of the loss rates for all those sub-portfolios. (3) When no other retail exposure category is available in the credit institution or should this category not be appropriate as a benchmark level, the qualifying revolving retail exposure portfolios of peer credit institutions, mortgage portfolios, or corporate portfolios may serve as possible alternative reference portfolios. (4) In the meaning of paragraph (1), in order to measure the volatility suitably, it can be used the coefficient of variation the standard deviation divided by the mean, and loss rate is defined as the realised loss within a fixed period of time, measured as percentage of the exposure class value. 3.1.1.3 Retail exposures secured by real estate collateral Art.55 Any retail exposure to which the credit institution assigns real estate collateral for its internal risk measurement purposes shall be classified as a retail exposure secured by real estate collateral. For retail exposures to which no real estate collateral has been assigned, the credit institution shall not consider potential proceeds from the value of real estate for loss given default estimation. 3.1.2 Corporate exposure class 3.1.2.1 Small and medium sized entities in the corporate exposure class Art.56 (1) In the meaning of Article 35 of Regulation NBR-NSC no.15/20/2006, as subsequently amended and supplemented, the term sales is defined as total gross revenue received by a firm from selling goods and services in the normal course of business. In case of an insurance companies, sales is defined as gross premium income. (2) For the purposes of Article 35 of the regulation mentioned in paragraph (1), the substitution of the total annual sales with the total assets on a voluntary basis may be possible when the credit institution can present evidence that this is at least an 25