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Basel ii Accord
Section 486 to 524 |
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486.
The criteria must be plausible and intuitive,
and must address the guarantor’s
ability
and
willingness to perform under the guarantee. The
criteria must also address the
likely
timing
of any payments and the degree to which the
guarantor’s ability to perform under
the
guarantee
is correlated with the borrower’s ability to
repay. The bank’s criteria must
also
consider
the extent to which residual risk to the
borrower remains, for example a
currency
mismatch
between the guarantee and the underlying
exposure.
487.
In adjusting borrower grades or LGD estimates
(or in the case of retail and
eligible
purchased
receivables, the process of allocating exposures
to pools), banks must take all
relevant
available information into
account.
Credit
derivatives
488.
The minimum requirements for guarantees are
relevant also for single-name
credit
derivatives.
Additional considerations arise in respect of
asset mismatches. The criteria
used
for
assigning adjusted borrower grades or LGD
estimates (or pools) for exposures
hedged
with
credit derivatives must require that the asset
on which the protection is based
(the
reference
asset) cannot be different from the underlying
asset, unless the conditions
outlined
in
the foundation approach are
met.
489.
In addition, the criteria must address the
payout structure of the credit derivative
and
conservatively
assess the impact this has on the level and
timing of recoveries. The bank
must
also consider the extent to which other forms of
residual risk remain.
For
banks using foundation LGD
estimates
490.
The minimum requirements outlined in paragraphs
480 to 489 apply to banks using
the
foundation LGD estimates with the following
exceptions:
(1)
The bank is not able to use an ‘LGD-adjustment’
option; and
(2)
The range of eligible guarantees and guarantors
is limited to those outlined in
paragraph
302.
(x)
Requirements specific to estimating PD and LGD
(or EL) for qualifying
purchased
receivables
491.
The following minimum requirements for risk
quantification must be satisfied for
any
purchased
receivables (corporate or retail) making use of
the top-down treatment of
default
risk
and/or the IRB treatments of dilution
risk.
492.
The purchasing bank will be required to group
the receivables into
sufficiently
homogeneous
pools so that accurate and consistent estimates
of PD and LGD (or EL) for
default
losses and EL estimates of dilution losses can
be determined. In general, the
risk
bucketing
process will reflect the seller’s underwriting
practices and the heterogeneity of
its
customers.
In
addition, methods and data for estimating PD,
LGD, and EL must comply with the existing risk
quantification standards for retail exposures.
In particular, quantification
should
reflect all information available to the
purchasing bank regarding the quality of
the
underlying
receivables, including data for similar pools
provided by the seller, by the
purchasing
bank, or by external sources. The purchasing
bank must determine whether the
data
provided by the seller are consistent with
expectations agreed upon by both
parties
concerning,
for example, the type, volume and on-going
quality of receivables
purchased.
Where
this is not the case, the purchasing bank is
expected to obtain and rely upon
more
relevant
data.
Minimum
operational requirements
493.
A bank purchasing receivables has to justify
confidence that current and
future
advances
can be repaid from the liquidation of (or
collections against) the receivables
pool.
To
qualify for the top-down treatment of default
risk, the receivable pool and overall
lending
relationship
should be closely monitored and controlled.
Specifically, a bank will have
to
demonstrate
the following:
Legal
certainty
494.
The structure of the facility must ensure that
under all foreseeable
circumstances
the
bank has effective ownership and control of the
cash remittances from the
receivables,
including
incidences of seller or servicer distress and
bankruptcy. When the obligor
makes
payments
directly to a seller or servicer, the bank must
verify regularly that payments
are
forwarded
completely and within the contractually agreed
terms. As well, ownership over
the
receivables
and cash receipts should be protected against
bankruptcy ‘stays’ or legal
challenges
that could materially delay the lender’s ability
to liquidate/assign the
receivables
or
retain control over cash
receipts.
Effectiveness
of monitoring systems
495.
The bank must be able to monitor both the
quality of the receivables and
the
financial
condition of the seller and servicer. In
particular:
•
The
bank must (a) assess the correlation among the
quality of the receivables
and
the
financial condition of both the seller and
servicer, and (b) have in place
internal
policies
and procedures that provide adequate safeguards
to protect against such
contingencies,
including the assignment of an internal risk
rating for each seller and
servicer.
•
The
bank must have clear and effective policies and
procedures for determining
seller
and servicer eligibility. The bank or its agent
must conduct periodic reviews
of
sellers
and servicers in order to verify the accuracy of
reports from the
seller/servicer,
detect fraud or operational weaknesses, and
verify the quality of the
seller’s
credit policies and servicer’s collection
policies and procedures. The
findings
of
these reviews must be well
documented.
•
The
bank must have the ability to assess the
characteristics of the receivables
pool,
including
(a)
over-advances;
(b)
history of the seller’s arrears, bad debts, and
bad
debt
allowances;
(c)
payment terms, and
(d)
potential contra accounts.
•
The
bank must have effective policies and procedures
for monitoring on an
aggregate
basis single-obligor concentrations both within
and across receivables
pools.
•
The
bank must receive timely and sufficiently
detailed reports of receivables
ageings
and
dilutions to
(a)
ensure compliance with the bank’s eligibility
criteria and
advancing
policies governing purchased receivables, and
(b)
provide an effective means with which to monitor
and confirm the seller’s terms of sale (e.g.
invoice date ageing) and
dilution.
Effectiveness
of work-out systems
496.
An effective programme requires systems and
procedures not only for
detecting
deterioration
in the seller’s financial condition and
deterioration in the quality of
the
receivables
at an early stage, but also for addressing
emerging problems pro-actively.
In
particular,
The bank should have clear and effective
policies, procedures, and
information
systems
to monitor compliance with
(a)
all contractual terms of the facility (including
covenants, advancing formulas, concentration
limits, early amortisation triggers, etc.) as
well as
(b)
the bank’s internal policies governing advance
rates and receivables eligibility.
The
bank’s systems should track covenant violations
and waivers as well as exceptions to established
policies and procedures.
•
To
limit inappropriate draws, the bank should have
effective policies and
procedures
for
detecting, approving, monitoring, and correcting
over-advances.
•
The
bank should have effective policies and
procedures for dealing with
financially
weakened
sellers or servicers and/or deterioration in the
quality of receivable pools.
These
include, but are not necessarily limited to,
early termination triggers in
revolving
facilities and other covenant protections, a
structured and disciplined
approach
to dealing with covenant violations, and clear
and effective policies and
procedures
for initiating legal actions and dealing with
problem receivables.
Effectiveness
of systems for controlling collateral, credit
availability, and cash
497.
The bank must have clear and effective policies
and procedures governing the
control
of receivables, credit, and cash. In
particular,
•
Written internal
policies must specify all material elements of
the receivables
purchase
programme, including the advancing rates,
eligible collateral, necessary
documentation,
concentration limits, and how cash receipts are
to be handled.
These
elements should take appropriate account of all
relevant and material factors,
including
the seller’s/servicer’s financial condition,
risk concentrations, and trends
in
the
quality of the receivables and the seller’s
customer base.
•
Internal systems must
ensure that funds are advanced only against
specified
supporting
collateral and documentation (such as servicer
attestations, invoices,
shipping
documents, etc.).
Compliance
with the bank’s internal policies and
procedures
498.
Given the reliance on monitoring and control
systems to limit credit risk, the
bank
should
have an effective internal process for assessing
compliance with all critical
policies
and
procedures, including
•
regular internal
and/or external audits of all critical phases of
the bank’s receivables
purchase
programme.
•
verification of the
separation of duties (i) between the assessment
of the
seller/servicer
and the assessment of the obligor and (ii)
between the assessment of
the
seller/servicer and the field audit of the
seller/servicer.
499.
A bank’s effective internal process for
assessing compliance with all critical
policies
and
procedures should also include evaluations of
back office operations, with
particular
focus
on qualifications, experience, staffing levels,
and supporting systems.
8. Validation of
internal estimates
500.
Banks must have a robust system in place to
validate the accuracy and
consistency
of
rating systems, processes, and the estimation of
all relevant risk components. A
bank
must
demonstrate to its supervisor that the internal
validation process enables it to
assess
the
performance of internal rating and risk
estimation systems consistently and
meaningfully.
501.
Banks must regularly compare realised default
rates with estimated PDs for
each
grade
and be able to demonstrate that the realised
default rates are within the
expected
range
for that grade. Banks using the advanced IRB
approach must complete such
analysis
for
their estimates of LGDs and EADs. Such
comparisons must make use of historical
data
that
are over as long a period as possible. The
methods and data used in such
comparisons
by
the bank must be clearly documented by the bank.
This analysis and documentation must be updated
at least annually.
502.
Banks must also use other quantitative
validation tools and comparisons
with
relevant
external data sources. The analysis must be
based on data that are appropriate
to
the
portfolio, are updated regularly, and cover a
relevant observation period. Banks’
internal
assessments
of the performance of their own rating systems
must be based on long data
histories,
covering a range of economic conditions, and
ideally one or more complete
business
cycles.
503.
Banks must demonstrate that quantitative testing
methods and other validation
methods
do not vary systematically with the economic
cycle. Changes in methods and
data
(both
data sources and periods covered) must be
clearly and thoroughly
documented.
504.
Banks must have well-articulated internal
standards for situations where
deviations
in
realised PDs, LGDs and EADs from expectations
become significant enough to call
the
validity
of the estimates into question. These standards
must take account of business
cycles
and
similar systematic variability in default
experiences. Where realised values continue
to
be
higher than expected values, banks must revise
estimates upward to reflect their
default
and
loss experience.
505.
Where banks rely on supervisory, rather than
internal, estimates of risk
parameters,
they
are encouraged to compare realised LGDs and EADs
to those set by the
supervisors.
The
information on realised LGDs and EADs should
form part of the bank’s assessment
of
economic
capital.
9.
Supervisory LGD and EAD
estimates
506.
Banks under the foundation IRB approach, which
do not meet the requirements
for
own-estimates
of LGD and EAD, above, must meet the minimum
requirements described in
the
standardised approach to receive recognition for
eligible financial collateral (as set out
in
Section
II.D: The standardised approach ─ credit risk
mitigation). They must meet the
following
additional minimum requirements in order to
receive recognition for
additional
collateral
types.
(i)
Definition of eligibility of CRE and RRE as
collateral
507.
Eligible CRE and RRE collateral for corporate,
sovereign and bank exposures
are
defined
as:
•
Collateral where the
risk of the borrower is not materially dependent
upon the
performance
of the underlying property or project, but
rather on the underlying
capacity
of the borrower to repay the debt from other
sources. As such, repayment
of
the facility is not materially dependent on any
cash flow generated by the
underlying CRE/RRE
serving as collateral;
(92) and
•
Additionally, the
value of the collateral pledged must not be
materially dependent on
the
performance of the borrower. This requirement is
not intended to preclude
situations
where purely macro-economic factors affect both
the value of the
collateral
and the performance of the
borrower.
(92) The Committee recognises that
in some countries where multifamily housing
makes up an important part of the housing market
and where public policy is supportive of that
sector, including specially established public
sector companies as major providers, the risk
characteristics of lending secured by mortgage
on such residential real estate can be similar
to those of traditional corporate exposures.
The national supervisor may under
such circumstances recognise mortgage on
multifamily residential real estate as eligible
collateral for corporate
exposures.
508.
In light of the generic description above and
the definition of corporate
exposures,
income
producing real estate that falls under the SL
asset class is specifically excluded
from
recognition as
collateral for corporate
exposures.
(93)
(93) As noted in footnote 73, in
exceptional circumstances for well-developed and
long-established markets, mortgages on office
and/or multi-purpose commercial premises and/or
multi-tenanted commercial premises may have the
potential to receive recognition as collateral
in the corporate portfolio. Please refer to
footnote 29 of paragraph 74 for a discussion of
the eligibility criteria that would
apply.
(ii)
Operational requirements for eligible
CRE/RRE
509.
Subject to meeting the definition above, CRE and
RRE will be eligible for
recognition
as
collateral for corporate claims only if all of
the following operational requirements are
met.
•
Legal
enforceability: any claim on a collateral taken
must be legally enforceable
in
all
relevant jurisdictions, and any claim on
collateral must be properly filed on
a
timely
basis. Collateral interests must reflect a
perfected lien (i.e. all legal
requirements
for establishing the claim have been fulfilled).
Furthermore, the
collateral
agreement and the legal process underpinning it
must be such that they
provide
for the bank to realise the value of the
collateral within a reasonable
timeframe.
•
Objective market
value of collateral: the collateral must be
valued at or less than the
current
fair value under which the property could be
sold under private contract
between
a willing seller and an arm’s-length buyer on
the date of valuation.
•
Frequent revaluation:
the bank is expected to monitor the value of the
collateral on a
frequent
basis and at a minimum once every year. More
frequent monitoring is
suggested
where the market is subject to significant
changes in conditions.
Statistical
methods of evaluation (e.g. reference to house
price indices, sampling)
may
be used to update estimates or to identify
collateral that may have declined
in
value
and that may need re-appraisal. A qualified
professional must evaluate the
property
when information indicates that the value of the
collateral may have
declined
materially relative to general market prices or
when a credit event, such as
default,
occurs.
•
Junior liens: In some
member countries, eligible collateral will be
restricted to
situations where the
lender has a first charge over the
property.
(94) Junior liens
may
be
taken into account where there is no doubt that
the claim for collateral is
legally
enforceable
and constitutes an efficient credit risk
mitigant. When recognised,
junior
liens
are to be treated using the C*/C** threshold,
which is used for senior liens.
In
such
cases, the C* and C** are calculated by taking
into account the sum of the
junior
lien and all more senior liens.
(94) In some of these
jurisdictions, first liens are subject to the
prior right of preferential creditors, such as
outstanding tax claims and employees’
wages.
510.
Additional collateral management requirements
are as follows:
•
The
types of CRE and RRE collateral accepted by the
bank and lending policies
(advance
rates) when this type of collateral is taken
must be clearly documented.
•
The
bank must take steps to ensure that the property
taken as collateral is
adequately
insured against damage or
deterioration.
•
The
bank must monitor on an ongoing basis the extent
of any permissible prior
claims
(e.g. tax) on the property.
•
The
bank must appropriately monitor the risk of
environmental liability arising
in
respect
of the collateral, such as the presence of toxic
material on a property.
(iii)
Requirements for recognition of financial
receivables
Definition
of eligible receivables
511.
Eligible financial receivables are claims with
an original maturity of less than
or
equal
to one year where repayment will occur through
the commercial or financial
flows
related
to the underlying assets of the borrower. This
includes both self-liquidating
debt
arising
from the sale of goods or services linked to a
commercial transaction and
general
amounts
owed by buyers, suppliers, renters, national and
local governmental authorities,
or
other
non-affiliated parties not related to the sale
of goods or services linked to a
commercial
transaction.
Eligible receivables do not include those
associated with securitisations,
subparticipations or credit
derivatives.
Operational
requirements
Legal
certainty
512.
The legal mechanism by which collateral is given
must be robust and ensure that
the
lender has clear rights over the proceeds from
the collateral.
513.
Banks must take all steps necessary to fulfil
local requirements in respect of
the
enforceability
of security interest, e.g. by registering a
security interest with a registrar. There should
be a framework that allows the potential lender
to have a perfected first priority claim over
the collateral.
514.
All documentation used in collateralised
transactions must be binding on all
parties
and
legally enforceable in all relevant
jurisdictions. Banks must have conducted
sufficient
legal
review to verify this and have a well founded
legal basis to reach this conclusion,
and
undertake
such further review as necessary to ensure
continuing enforceability.
515.
The collateral arrangements must be properly
documented, with a clear and
robust
procedure
for the timely collection of collateral
proceeds. Banks’ procedures should
ensure
that
any legal conditions required for declaring the
default of the customer and
timely
collection
of collateral are observed. In the event of the
obligor’s financial distress or
default,
the
bank should have legal authority to sell or
assign the receivables to other parties
without
consent
of the receivables’ obligors.
Risk
management
516.
The bank must have a sound process for
determining the credit risk in
the
receivables.
Such a process should include, among other
things, analyses of the
borrower’s
business
and industry (e.g. effects of the business
cycle) and the types of customers
with
whom
the borrower does business. Where the bank
relies on the borrower to ascertain
the
credit
risk of the customers, the bank must review the
borrower’s credit policy to ascertain its
soundness and credibility.
517.
The margin between the amount of the exposure
and the value of the
receivables
must
reflect all appropriate factors, including the
cost of collection, concentration within
the
receivables
pool pledged by an individual borrower, and
potential concentration risk
within
the
bank’s total exposures.
518.
The bank must maintain a continuous monitoring
process that is appropriate for
the
specific
exposures (either immediate or contingent)
attributable to the collateral to be utilised as
a risk mitigant. This process may include, as
appropriate and relevant, ageing reports,
control of trade documents, borrowing base
certificates, frequent audits of
collateral,
confirmation
of accounts, control of the proceeds of accounts
paid, analyses of dilution
(credits
given by the borrower to the issuers) and
regular financial analysis of both
the
borrower
and the issuers of the receivables, especially
in the case when a small number
of
large-sized
receivables are taken as collateral. Observance
of the bank’s overall
concentration
limits should be monitored. Additionally,
compliance with loan covenants,
environmental
restrictions, and other legal requirements
should be reviewed on a regular
basis.
519.
The receivables pledged by a borrower should be
diversified and not be unduly
correlated
with the borrower. Where the correlation is
high, e.g. where some issuers of
the
receivables
are reliant on the borrower for their viability
or the borrower and the issuers
belong
to a common industry, the attendant risks should
be taken into account in the
setting
of
margins for the collateral pool as a whole.
Receivables from affiliates of the
borrower
(including
subsidiaries and employees) will not be
recognised as risk mitigants.
520.
The bank should have a documented process for
collecting receivable payments
in
distressed
situations. The requisite facilities for
collection should be in place, even when
the
bank
normally looks to the borrower for
collections.
Requirements
for recognition of other
collateral
521.
Supervisors may allow for recognition of the
credit risk mitigating effect of
certain
other
physical collateral. Each supervisor will
determine which, if any, collateral types in
its
jurisdiction
meet the following two
standards:
•
Existence of liquid
markets for disposal of collateral in an
expeditious and
economically
efficient manner.
•
Existence of well
established, publicly available market prices
for the collateral.
Supervisors
will seek to ensure that the amount a bank
receives when collateral is
realised
does not deviate significantly from these market
prices.
522.
In order for a given bank to receive recognition
for additional physical collateral,
it
must
meet all the standards in paragraphs 509 and
510, subject to the following
modifications.
•
First
Claim: With the sole exception of permissible
prior claims specified in
footnote
94,
only first liens on, or charges over, collateral
are permissible. As such, the
bank
must
have priority over all other lenders to the
realised proceeds of the
collateral.
The
loan agreement must include detailed
descriptions of the collateral plus
detailed
specifications
of the manner and frequency of
revaluation.
•
The
types of physical collateral accepted by the
bank and policies and practices
in
respect
of the appropriate amount of each type of
collateral relative to the
exposure
amount
must be clearly documented in internal credit
policies and procedures and
available
for examination and/or audit
review.
•
Bank
credit policies with regard to the transaction
structure must address
appropriate
collateral requirements relative to the exposure
amount, the ability to
liquidate
the collateral readily, the ability to establish
objectively a price or market
value,
the frequency with which the value can readily
be obtained (including a
professional
appraisal or valuation), and the volatility of
the value of the collateral.
The
periodic revaluation process must pay particular
attention to
“fashion-sensitive”
collateral
to ensure that valuations are appropriately
adjusted downward of fashion,
or
model-year, obsolescence as well as physical
obsolescence or deterioration.
•
In
cases of inventories (e.g. raw materials,
work-in-process, finished goods,
dealers’
inventories
of autos) and equipment, the periodic
revaluation process must
include
physical
inspection of the collateral.
10.
Requirements for recognition of
leasing
523.
Leases other than those that expose the bank to
residual value risk (see
paragraph
524)
will be accorded the same treatment as exposures
collateralised by the same type
of
collateral.
The minimum requirements for the collateral type
must be met (CRE/RRE or other collateral). In
addition, the bank must also meet the following
standards:
•
Robust risk
management on the part of the lessor with
respect to the location of
the
asset,
the use to which it is put, its age, and planned
obsolescence;
•
A
robust legal framework establishing the lessor’s
legal ownership of the asset
and
its
ability to exercise its rights as owner in a
timely fashion; and
•
The
difference between the rate of depreciation of
the physical asset and the rate
of
amortisation
of the lease payments must not be so large as to
overstate the CRM
attributed
to the leased assets.
524.
Leases that expose the bank to residual value
risk will be treated in the
following
manner.
Residual value risk is the bank’s exposure to
potential loss due to the fair value
of
the
equipment declining below its residual estimate
at lease inception.
•
The
discounted lease payment stream will receive a
risk weight appropriate for
the
lessee’s
financial strength (PD) and supervisory or
own-estimate of LGD, which ever
is
appropriate.
•
The
residual value will be risk-weighted at
100%.
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