Basel
ii in the United States of America
From the
Basel ii
Compliance Professionals Association (BCPA),
the largest association of Basel ii Professionals in the
world
Final Rule, USA: Risk-Based Capital Standards:
Advanced Capital Adequacy Framework — Basel II
Definition of default
Wholesale default
In the
ANPR, the agencies proposed to define default for a
wholesale exposure as either or both of the following
events:
(i)
the bank determines that the borrower is unlikely to pay
its obligations to the bank in full, without recourse to
actions by the bank such as the realization of
collateral; or
(ii)
the borrower is more than 90 days past due on principal
or interest on any material obligation to the bank.
The
ANPR’s definition
of default was generally consistent with the New Accord.
A
number of commenters on the ANPR encouraged the agencies
to use a wholesale definition of default that varied
from the New Accord but conformed more closely to that
used by bank risk managers.
Many
of these commenters recommended that the agencies define
default for wholesale exposures as the entry into
non-accrual or charge-off status.
In the
proposed rule, the agencies amended the ANPR definition
of default to respond to these concerns.
Under
the proposed definition of default, a bank’s wholesale
obligor would be in default if, for any wholesale
exposure of the bank to the obligor, the bank had
(i)
placed the exposure on non-accrual status consistent
with the Consolidated Report of Condition and Income
(Call Report) Instructions or the Thrift Financial
Report (TFR) and the TFR Instruction Manual;
(ii)
taken a full or partial charge-off or write-down on the
exposure due to the distressed financial condition of
the obligor; or
(iii)
incurred a credit-related loss of 5 percent or more of
the exposure’s initial carrying value in connection with
the sale of the exposure or the transfer of the exposure
to the held-for-sale, available-for-sale, trading
account, or other reporting category.
The
agencies received extensive comment on the proposed
definition of default for wholesale exposures.
Commenters observed that the proposed definition of
default was different from and more prescriptive than
the definition in the New Accord and employed in other
major jurisdictions.
They
asserted that the proposed definition would impose
unjustifiable systems burden and expense on banks
operating across multiple jurisdictions.
Commenters also asserted that many banks’ data
collection systems are based on the New Accord’s
definition of default, and therefore historical data
relevant to the proposed definition of default are
limited.
Moreover, commenters expressed concern that risk
parameters estimated using the proposed definition of
default would differ materially from those estimated
using the New Accord’s definition of default, resulting
in
different capital requirements for U.S. banks relative
to their foreign peers.
The 5
percent credit-related loss trigger in the proposed
definition of default for wholesale obligors was the
focus of significant commenter concern.
Commenters asserted that the trigger inappropriately
imported LGD and maturity-related considerations into
the definition of default, could hamper the use of loan
sales as a risk management practice, and could cause
obligors that are performing on their obligations to be
considered defaulted.
These
commenters also claimed that the 5 percent trigger would
add significant implementation burden by, for example,
requiring banks to distinguish between credit-related
and non-credit-related losses on sale.
Many
commenters requested that the agencies conform the U.S.
wholesale definition of default to the New Accord.
Other
commenters requested that banks be allowed the option to
apply either the U.S. or the New Accord definition of
default.
The
agencies agree that the proposed definition of default
for wholesale obligors could have unintended
consequences for implementation burden and international
consistency.
Therefore, the final rule contains a definition of
default for wholesale obligors that is similar to the
definition proposed in the ANPR and consistent with the
New Accord. Specifically, under the final rule, a bank’s
wholesale obligor is in default if, for any wholesale
exposure of the bank to the obligor:
(i)
the bank considers that the obligor is unlikely to pay
its credit obligations to the bank in full, without
recourse by the bank to actions such as realizing
collateral (if held); or
(ii)
the obligor is past due more than 90 days on any
material credit obligation to the bank.
The
final rule also clarifies, consistent with the New
Accord, that an overdraft is past due once the obligor
has
breached an advised limit or has been advised of a limit
smaller than the current outstanding balance.
Consistent with the New Accord, the following elements
may be indications of
unlikeliness to pay
under this definition:
(i)
The bank places the exposure on non-accrual status
consistent with the Call Report Instructions or the TFR
and the TFR Instruction Manual;
(ii)
The bank takes a full or partial charge-off or
write-down on the exposure due to the distressed
financial condition of the obligor;
(iii)
The bank incurs a material credit-related loss in
connection with the sale of the exposure or the transfer
of the exposure to the held-for-sale,
available-for-sale, trading account, or other reporting
category;
(iv)
The bank consents to a distressed restructuring of the
exposure that is likely to result in a diminished
financial obligation caused by the material forgiveness
or postponement of principal, interest or (where
relevant) fees;
(v)
The bank has filed as a creditor of the obligor for
purposes of the obligor’s bankruptcy under the U.S.
Bankruptcy Code (or a similar proceeding in a foreign
jurisdiction regarding the obligor’s credit obligation
to the bank); or
(vi)The
obligor has sought or has been placed in bankruptcy or
similar protection that would avoid or delay repayment
of the exposure to the bank.
If a
bank carries a wholesale exposure at fair value for
accounting purposes, the bank’s practices for
determining unlikeliness to pay for purposes of the
definition of default should be consistent with the
bank’s practices for determining credit-related declines
in the fair value of the exposure.
Like
the proposed definition of default for wholesale
obligors, the final rule states that a wholesale
exposure to an obligor remains in default until the bank
has reasonable assurance of repayment and performance
for all contractual principal and interest payments on
all exposures of the bank to the obligor (other than
exposures that have been fully written-down or
charged-off).
The
agencies expect a bank to employ standards for
determining whether it has a reasonable assurance of
repayment and performance that are similar to those for
determining whether to restore a loan from non-accrual
to accrual status.
Retail
default
In
response to comments on the ANPR, the agencies proposed
to define default for retail exposures according to the
timeframes for loss classification that banks generally
use for internal purposes.
These
timeframes are embodied in the
FFIEC’s Uniform
Retail Credit Classification and Account Management
Policy.
Specifically, revolving retail exposures and residential
mortgage exposures would be in default at 180 days past
due; other retail exposures would be in default at 120
days past due. In addition, a retail exposure would be
in default if the bank had taken a full or partial
charge-off or write-down of principal on the exposure
for credit-related reasons.
Such
an exposure would remain in default until the bank had
reasonable assurance of repayment and performance for
all contractual principal and interest payments on the
exposure.
Although some commenters supported the proposed rule’s
retail definition of default, others urged the agencies
to adopt a 90-days-past-due default trigger consistent
with the New Accord’s definition of default for retail
exposures.
Other
commenters uested that a non-accrual trigger be added to
the retail definition of default similar to
that
in the proposed wholesale definition of default.
The
commenters viewed this as a practical way to allow a
foreign banking organization to harmonize the U.S.
retail definition of default to a home country
definition of default that has a 90-days-past-due
trigger.
The
agencies believe that adding a non-accrual trigger to
the retail definition of default is not appropriate.
Retail non-accrual practices vary considerably among
banks, and adding a non-accrual trigger to the retail
definition of default would result in greater
inconsistency among banks in the treatment of retail
exposures.
Moreover, a bank that considers retail exposures to be
defaulted at 90 days past due could have significantly
different risk parameter estimates than one that uses
120- and 180-days-past-due thresholds.
Such a
bank would likely have higher PD estimates and lower LGD
estimates due to the established tendency of a
nontrivial proportion of U.S. retail exposures to “cure”
or return to performing status after becoming 90 days
past due and before becoming 120 or 180 days past due.
The
agencies believe that the 120- and 180-dayspast- due
thresholds, which are consistent with national
discretion provided by the New Accord, reflect a point
at which retail exposures in the United States are
unlikely to return to performing status.
Therefore, the agencies are incorporating the proposed
retail definition of default without substantive change
in the final rule.
(Parallel to the full or partial charge-off or
write-down trigger for retail exposures not held at fair
value, the
agencies added a material negative fair value adjustment
of principal for credit-related reasons trigger for
retail exposures held at fair value.)
The
New Accord provides discretion for national supervisors
to set the retail default trigger at up to 180 days past
due for different products, as appropriate to local
conditions.
Accordingly, banks implementing the IRB approach in
multiple jurisdictions may be subject to different
retail definitions of default in their home and host
jurisdictions.
The
agencies recognize that it could be costly and
burdensome for a U.S. bank to track default data and
estimate risk parameters based on both the U.S.
definition of default and the definitions of default in
non-U.S. jurisdictions where subsidiaries of the U.S.
bank implement the IRB approach.
The
agencies are therefore incorporating flexibility into
the retail definition of default.
Specifically, for a retail exposure held by a U.S.
bank’s non-U.S. subsidiary subject to an internal
ratings-based approach to capital adequacy consistent
with the New Accord in a non-U.S. jurisdiction, the
final rule allows the bank to elect to use the
definition of default of that jurisdiction, subject to
prior approval by the bank’s primary Federal supervisor.
The
primary Federal supervisor will revoke approval for a
bank to use this provision if the supervisor finds that
the bank uses the provision to arbitrage differences in
national definitions of default.
The
definition of default for retail exposures differs from
the definition for the wholesale portfolio in that the
retail default definition applies on an exposure-by
exposure basis rather than on an obligor-by-obligor
basis.
In
other words, default on one retail exposure does not
require a bank to treat all other retail obligations of
the same borrower to the bank as defaulted.
This
difference reflects the fact that banks generally manage
retail credit risk based on segments of similar
exposures rather than through the assignment of ratings
to particular borrowers.
In
addition, it is quite common for retail borrowers that
default on some of their obligations to continue payment
on others.
Although the retail definition of default does not
explicitly include credit-related losses in connection
with loan sales and the agencies have replaced the 5
percent credit related loss threshold for wholesale
exposures with a less prescriptive treatment that is
consistent with the New Accord, the agencies expect
banks to ensure that exposure sales do not bias or
otherwise distort the estimated risk parameters assigned
by a bank to its
wholesale exposures and retail segments.
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