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BIPRU 4.1 The IRB approach: Application, purpose and overview

Application

BIPRU 4.1.1 R

1 BIPRU 4 applies to a3BIPRUfirm with an IRB permission.

Purpose

BIPRU 4.1.2 G

3Pursuant to the third paragraph of article 95(2) of the EUCRR, BIPRU 4 implements the following provisions of the Banking Consolidation Directive:

  1. (1)

    Articles 84 - 89; and

  2. (2)

    Annex VII.

BIPRU 4.1.3 G

3Pursuant to the third paragraph of article 95(2) of the EUCRR, BIPRU 4 also implements Annex VIII of the Banking Consolidation Directive so far as it applies to the IRB approach. In particular, it implements (in part):

  1. (1)

    from Part 1 of that Annex, points 12-16, 19-22, 26(g)(ii) and 27;

  2. (2)

    from Part 2 of that Annex, points 8-11; and

  3. (3)

    from Part 3 of that Annex, points 1, 11, 20, 23-24, 58(h), 61, 64-79 and 90-93.

BIPRU 4.1.4 G

3Similarly, BIPRU 4 also implements article 40 of the Capital Adequacy Directive as it applies to the IRB approach.

BIPRU 4.1.5 G

Other material on the IRB approach can be found in BIPRU 8 (Group risk), BIPRU 9 (Securitisation), BIPRU 13 (The calculation of exposure values for financial derivatives, securities financing transactions and long settlement transactions) and BIPRU 14 (Capital requirements for settlement and counterparty risk). BIPRU 5 (Credit risk mitigation) also contains material applicable to the IRB approach.

Overview

BIPRU 4.1.6 G

The IRB approach is an alternative to the standardised approach for calculating a firm's credit risk capital requirements. It may be applied to all a firm'sexposures or to some of them, subject to various limitations on partial use as set out in BIPRU 4.2. Under the IRB approach capital requirements are based on a firm's own estimates of certain parameters together with other parameters set out in the Banking Consolidation Directive.

BIPRU 4.1.7 G

Exposures are divided into a number of distinct exposure classes. These are listed in BIPRU 4.3.2 R. There is a special treatment for purchased receivables, although they do not form an exposure class on their own.

BIPRU 4.1.8 G

For exposures in the sovereign, institution and corporate IRB exposure class, there is a foundation IRB approach under which a firm provides its own estimates of PD and an advanced IRB approach under which a firm additionally provides its own estimates of LGD and conversion factors. The distinction between the foundation IRB approach and the advanced IRB approach only applies to this IRB exposure class.

BIPRU 4.1.9 G

For retail exposures, a firm provides its own estimates of PD, LGD and conversion factors.

BIPRU 4.1.10 G

For the corporate exposure class there is a separate sub-class of specialised lending exposure. A firm may calculate risk weights for these exposures, where it is able to do so, in the same way as it does for the rest of its corporate exposure class, i.e. using the foundation IRB approach or the advanced IRB approach. Where a firm is not able to use this approach it may calculate risk weights for specialised lending exposures by slotting them into predetermined risk weights.

BIPRU 4.1.11 G

For equity exposures there are two approaches based on market based measures and a third under which a firm uses its own estimates of PD only.

IRB permissions: general

BIPRU 4.1.12 G

The rules in GENPRU and BIPRU do not allow a firm to use the IRB approach. A firm that wishes to use the IRB approach should therefore apply for permission to use the IRB approach using the application procedure explained in BIPRU 1.3. If a firm's application is granted, its terms will be set out in an IRB permission.

BIPRU 4.1.13 G

The appropriate regulator recognises that the nature of IRB approaches will vary between firms. The scope of and the requirements and conditions set out in an IRB permission may therefore differ in substance or detail from BIPRU 4 in order to address individual circumstances adequately. However any differences will only be allowed if they are compliant with the Banking Consolidation Directive. An IRB permission will implement any such variation by modifying the relevant provisions of GENPRU and BIPRU. An IRB permission may also include additional conditions to meet the particular circumstances of the firm.

BIPRU 4.1.14 G
  1. (1)

    The appropriate regulator will only grant an IRB permission if it is satisfied that the firm's systems for the management and rating of credit risk exposures are sound and implemented with integrity and, in particular, that they meet the standards in BIPRU 4.2.2 R in accordance with the minimum IRB standards.

  2. (2)

    Under BIPRU 4.2.11 R, a firm applying for an IRB permission is required to demonstrate that it has been using for the IRB exposure classes in question rating systems that were broadly in line with the minimum IRB standards for internal risk measurement and management purposes for at least three years prior to the date of its IRB permission.

  3. (3)

    Under BIPRU 4.2.13 R, a firm applying for the use of own estimates of LGDs and/or conversion factors should demonstrate that it has been estimating and employing own estimates of LGDs and/or conversion factors in a manner that was broadly consistent with the minimum IRB standards for use of own estimates for at least three years prior to the date of its IRB permission or of a variation of its IRB permission that, in either case, entitles the firm to use own estimates of LGDs and/or conversion factors.

Link to standard rules: Incorporation of the IRB output into the capital calculation

BIPRU 4.1.15 G

An IRB permission will modify GENPRU 2.1.51 R (Calculation of the credit risk capital requirement) by amending, to the extent set out in the IRB permission, the calculation of the credit risk capital requirement in accordance with BIPRU 4 and the other provisions of the Handbook relating to the IRB approach.

BIPRU 4.1.16 R

A firm must calculate its credit risk capital component as the sum of:

  1. (1)

    (for exposures to which the standardised approach is applied) the credit risk capital component as calculated under BIPRU 3.1.5 R; and

  2. (2)

    (for exposures to which the IRB approach is applied to which the standardised approach would otherwise apply in accordance with BIPRU 3.1.5 R (Credit risk capital component)), 8% of the total of the firm'srisk weighted exposure amounts calculated in accordance with the IRB approach.

BIPRU 4.1.17 G

For exposures covered by an IRB permission, BIPRU 5 (Credit risk mitigation) is modified by BIPRU 4.10.

BIPRU 4.1.18 G

Under BIPRU 4.9, a firm is required to deal with securitisation positions under those provisions of BIPRU 9 applicable to a firm using the IRB approach.

BIPRU 4.1.19 G

Exposures treated under BIPRU 13 are required to be dealt with in accordance with the IRB approach to the extent set out in BIPRU 13.

BIPRU 4.1.20 G

By modifying GENPRU 2.1.51 R to allow the firm to use the IRB approach to calculate all or part of its risk weighted exposure amounts, the appropriate regulator is treating it like an application rule. The modification means that the provisions of BIPRU relating to the IRB approach supersede the rules relating to the standardised approach for exposures coming within the scope of the IRB permission.

BIPRU 4.1.21 R

A reference in the Handbook to a provision of the IRB approach, in the case of a firm:

  1. (1)

    excludes any provision of the IRB approach set out in the Handbook that is not applied to that firm by its IRB permission;

  2. (2)

    includes any additional provision contained in the firm'sIRB permission; and

  3. (3)

    takes into account any other amendments made to the provisions in the Handbook relating to the IRB approach made by the firm'sIRB permission.

BIPRU 4.1.22 R

To the extent that a firm'sIRB permission does not allow it to use a particular approach in the Handbook relating to the IRB approach the Handbook provision in question does not apply to the firm.

BIPRU 4.1.23 R

If a provision of the Handbook relating to the IRB approach says that a firm may do something if its IRB permission allows it, a firm may do that thing unless its IRB permission expressly says that it may not do so except that:

  1. (1)

    BIPRU 4.2.18 R - BIPRU 4.2.19 R (Sequential implementation of IRB approach) and BIPRU 4.2.26 R (1)-BIPRU 4.2.26R (5) (Combined use of standardised approach with IRB approach) only apply if expressly permitted by a firm'sIRB permission;

  2. (2)

    a firm may not use the advanced IRB approach for the sovereign, institution and corporate IRB exposure class except to the extent expressly permitted by the firm'sIRB permission;

  3. (3)

    if a firm uses its own estimates of LGD and conversion factors it may only take into account unfunded credit protection to reduce LGD in the manner set out in its IRB permission;

  4. (4)

    if a firm uses its own estimates of LGD and conversion factors it may only recognise the effects of financial collateral in the manner set out in its IRB permission;

    244
  5. (5)

    a firm must deal with equity exposures in the manner set out in its IRB permission; and

  6. (6)

    (in the case of collateral that is only eligible for recognition under paragraph 21 of Part 1 of Annex VIII of the Banking Consolidation Directive (Other physical collateral)) a firm may not recognise as eligible collateral an item of a type referred to in BIPRU 4.10.16 R (Other physical collateral) unless that item is of a type specified as permitted in its IRB permission.

BIPRU 4.1.24 G

An IRB permission will set out firm-specific material. This will generally include:

  1. (1)

    details about the firm's methodology for carrying out the IRB approach, including the models and rating systems that a firm should use;

  2. (2)

    reporting requirements; and

  3. (3)

    requirements about internal control structure.

Compliance

BIPRU 4.1.25 R

If a firm ceases to comply with the requirements of the IRB approach, it must either present to the appropriate regulator a plan for a timely return to compliance or demonstrate that the effect of non-compliance is immaterial.

[Note: BCD Article 84(5)]

BIPRU 4.1.26 G

If a firm ceases to comply with the requirements of the IRB approach, the appropriate regulator may revoke the IRB permission or take other appropriate supervisory action.

BIPRU 4.1.27 G

For the purposes of BIPRU 4.1.25 R, the appropriate regulator will expect a firm to demonstrate that, taking into account all instances where the firm has not complied with the requirements of the IRB approach, the effect of non-compliance is immaterial.

BIPRU 4.2 The IRB approach: High level material

Application

BIPRU 4.2.1 R

This section applies to all exposures treated under the IRB approach.

General approach to granting an IRB permission

BIPRU 4.2.2 R

A firm's systems for the management and rating of credit risk exposures must be sound and implemented with integrity and, in particular, they must meet the following standards in accordance with the minimum IRB standards:

  1. (1)

    the firm'srating systems provide for a meaningful assessment of obligor and transaction characteristics, a meaningful differentiation of risk and accurate and consistent quantitative estimates of risk;

  2. (2)

    internal ratings and default and loss estimates used in the calculation of capital requirements and associated systems and processes play an essential role in the risk management and decision-making process, and in the credit approval, internal capital allocation and corporate governance functions of the firm;

  3. (3)

    the firm has a credit risk control unit responsible for its rating systems that is appropriately independent and free from undue influence;

  4. (4)

    the firm collects and stores all relevant data to provide effective support to its credit risk measurement and management process; and

  5. (5)

    the firm documents its rating systems, the rationale for their design and validates its rating systems.

[Note:BCD Article 84(2) (part)]

BIPRU 4.2.3 R

Where an EEA parent institution3 and its subsidiary undertakings or an EEA parent financial holding company3 and its subsidiary undertakings or an EEA parent mixed financial holding company and its subsidiary undertakings6 use the IRB approach on a unified basis, the question whether the minimum IRB standards are met is answered by considering the parent undertaking and its subsidiary undertakings together,6 unless the firm'sIRB permission specifies otherwise.

[Note: BCD Article 84(2) (part)]

3 3

Outsourcing

BIPRU 4.2.4 G
  1. (1)

    This guidance sets out the basis on which a firm may rely upon a rating system or data provided by another member of its group.

  2. (2)

    A firm may rely upon a rating system or data provided by another member of its group if the following conditions are satisfied:

    1. (a)

      the firm only does so to the extent that it is appropriate, given the nature and scale of the firm's business and portfolios and the firm's position within the group;

    2. (b)

      the group is an EEA banking and investment group;

    3. (c)

      the integrity of the firm's systems and controls is not adversely affected;

    4. (d)

      the outsourcing of these functions meets the requirements of SYSC; and

    5. (e)

      (if the provision of the rating system or data is not carried out in the United Kingdom or in the jurisdiction of the competent authority that is the lead regulator of the group) the firm can demonstrate to the appropriate regulator that the ability of the appropriate regulator and that lead regulator to carry out their responsibilities under the Handbook, the Banking Consolidation Directive and the Capital Adequacy Directive are not adversely affected.

  3. (3)

    If a firm does use a rating system or data provided by another member of its group, the requirements in BIPRU 4 continue to apply to that firm in respect of that rating system and data. A firm cannot absolve itself of the responsibility for complying with those requirements by claiming that any breach is caused by the actions of a third party to which the firm has delegated tasks. The rating system and data provision are still those of the firm, even though personnel elsewhere in the firm's group are carrying out these functions on its behalf. So any references in BIPRU to what a firm, its personnel and its management should and should not do still apply.

  4. (4)

    If a firm does use a rating system or data provided by another group member, the firm'sgoverning body should formally delegate those functions to the persons or bodies that are to carry them out.

  5. (5)

    Before delegating the provision of a rating system or data to another group member, the firm's governing body should have explicitly considered the arrangement and decided that it is appropriate and that it enables the firm to meet the conditions in (2).

Assessment and estimation

BIPRU 4.2.5 G
  1. (1)

    This paragraph provides guidance on BIPRU 4.2.2 R and in particular BIPRU 4.2.2 R (1).

  2. (2)

    The information that a firm produces or uses for the purpose of the IRB approach should be reliable and take proper account of the different users of the information produced (customers, shareholders, regulators and other market participants).

  3. (3)

    A firm should establish quantified and documented targets and standards, against which it should test the accuracy of data used in its rating systems.

  4. (4)

    Tests under (3) might include:

    1. (a)

      report and accounts reconciliation, including completeness in relation to (b);

    2. (b)

      whether every exposure has a PD, LGD and, if applicable, conversion factor for reporting purposes;

    3. (c)

      whether the firm's risk control environment has key risk indicators for the purpose of monitoring and ensuring data accuracy;

    4. (d)

      whether the firm has an adequate business and information technology infrastructure with fully documented processes;

    5. (e)

      whether the firm has clear and documented standards on ownership of data (including inputs and manipulation) and timeliness of current data (daily, monthly, real time); and

    6. (f)

      whether the firm has a comprehensive quantitative audit programme.

  5. (5)

    The reconciliation referred to in 4(a) should be reasonably fit for purpose. In particular it should meet the standards in (6) and (7).

  6. (6)

    For data inputs, testing for accuracy of data, including the reconciliation referred to in 4(a), should be sufficiently detailed so that, together with other available evidence, it gives reasonable assurance that data input into the rating system is accurate, complete and appropriate. Input data fails the required standard if it gives rise to a serious risk of material misstatement in the capital requirement either immediately or subsequently.

  7. (7)

    For data outputs, the firm, as part of the reconciliation referred to in 4(a), should be able to identify and explain material differences between the outputs produced under accounting standards and those produced under the requirements of the IRB approach, including in relation to areas that address similar concepts in different ways (for example expected loss on the one hand and accounting provisions on the other).

  8. (8)

    A firm should have clear and documented standards and policies about the use of data in practice (including information technology standards) which should in particular cover the firm's approach to the following:

    1. (a)

      data access and security;

    2. (b)

      data integrity, including the accuracy, completeness, appropriateness and testing of data; and

    3. (c)

      data availability.

Further requirements concerning the use test

BIPRU 4.2.6 R

If a firm uses separate models for the purpose of the IRB approach and for its internal purposes as referred to in BIPRU 4.2.2 R (2) it must be able to demonstrate the reasonableness of any differences between those models.

BIPRU 4.2.7 G
  1. (1)

    This paragraph provides guidance on BIPRU 4.2.2 R and in particular BIPRU 4.2.2 R (2).

  2. (2)

    The IRB approach as applicable to a firm should be an integral part of its business and risk management processes and procedures to the extent that credit risk is relevant to them. It should also have a substantial influence on its decision-making and actions.21

    1. (a)

      particular regard should be had to the use of the IRB approach in:

      1. (i)

        credit approval;

      2. (ii)

        individual and portfolio limit setting;

      3. (iii)

        reporting of credit risk information; and

      4. (iv)

        provisioning;21

    2. (b)

      other relevant aspects include:

      1. (i) 2

        assessment of economic capital;

      2. (ii)

        2internal capital allocation so far as related to credit risk;

      3. (iii)

        2risk appetite;

      4. (iv)

        2strategy and acquisitions;

      5. (v)

        2profitability and performance; and

      6. (vi)

        2performance-related remuneration;

    3. (c)

      the carrying out of the firm's obligations under the overall Pillar 2 rule; and

    4. (d)

      matters relating to the firm's infrastructure, including information technology, skills and resources and organisational culture.

BIPRU 4.2.8 G

This paragraph provides further guidance on BIPRU 4.2.2 R and in particular BIPRU 4.2.2 R (2). In the appropriate regulator's view risk management has an essential role in informing risk decisions. However, an essential role does not necessarily mean an exclusive role or even always a primary role. There may be justifiable differences between the IRB approach and the firm's use of rating systems for its internal purposes as referred to in BIPRU 4.2.2 R (2). For example, internal standards and policies may refer to estimates of PD and LGD for the length of the asset rather than to estimates based on a one-year period (in the case of PD estimates) or on an economic downturn (in the case of LGD estimates) required by the IRB approach.

BIPRU 4.2.9 G

If a firm uses scorecards for its internal credit approval process and the models it uses for the purpose of the IRB approach are fundamentally different from those scorecards, a firm's demonstration of how this is compatible with BIPRU 4.2.2 R (2) might include demonstrating that estimates calculated under the IRB approach are used to change sanctioning decisions at an individual or portfolio level. Examples of this might include amending cut-offs, the application of policy rules, the revision of an existing scorecard or the introduction of a new one or taking strategic decisions on which segments of the market to target.

BIPRU 4.2.10 G

To the extent that a firm uses LGD estimates in its internal risk management processes that differ from the downturn LGDs used in the calculation of risk weighted assets3 (see BIPRU 4.3.103 R), the reasons for the difference should be documented in accordance with BIPRU 4.3.109 R.

Requirements concerning the experience requirement

BIPRU 4.2.11 R

A firm must be able to demonstrate that it has been using for the IRB exposure classes in question rating systems that were broadly in line with the minimum IRB standards for internal risk measurement and management purposes for at least three years prior to the date of its IRB permission.

[Note:BCD Article 84(3)]

BIPRU 4.2.12 G

In meeting the experience requirement under BIPRU 4.2.11 R, the appropriate regulator would expect a firm to be able to demonstrate that it has been:

  1. (1)

    operating an internal rating system with estimates of PD;

  2. (2)

    meeting the standards in BIPRU 4 for senior management knowledge and reporting; and

  3. (3)

    meeting the standards in BIPRU 4 relating to the use of rating systems in its business;

for the required minimum 3 year period.

BIPRU 4.2.13 R

A firm that has applied for the use of own estimates of LGDs and/or conversion factors must be able to demonstrate to the appropriate regulator that it has been estimating and employing own estimates of LGDs and/or conversion factors in a manner that was broadly consistent with the minimum IRB standards for use of own estimates of those parameters for at least three years prior to the date of its IRB permission or of a variation of its IRB permission that, in either case, entitled the firm to use own estimates of LGDs and/or conversion factors.

[Note:BCD Article 84(4)]

BIPRU 4.2.14 G

In meeting the experience requirement under BIPRU 4.2.13 R, the appropriate regulator would expect a firm to be able to demonstrate that it has been:

  1. (1)

    operating an internal rating system with estimates of LGD and with conversion factors; and

  2. (2)

    compliant with BIPRU 4.2.11 R as applied to the advanced IRB approach.

for the required minimum 3 year period.

BIPRU 4.2.15 G

In the appropriate regulator's view the standard required by BIPRU 4.2.11 R and BIPRU 4.2.13 R is for a rating system to be improved in the light of experience during the three year period so that it meets the minimum requirements more fully for the last year than for the two prior years, provided that the rating system has not changed so profoundly that experience from the first or second years becomes of marginal relevance in assessing the reliability of the changed rating system.

Implementation of the internal ratings based approach

BIPRU 4.2.16 R

A firm must comply with any requirements in its IRB permission relating to the matters described in BIPRU 4.2.17 R - BIPRU 4.2.35 G.

BIPRU 4.2.17 R

Without prejudice to BIPRU 4.2.26 R, a firm and any parent undertaking and its subsidiary undertakings must implement the IRB approach for all exposures.

[Note: BCD Article 85(1) (part)]

BIPRU 4.2.18 R

To the extent that a firm'sIRB permission permits this, implementation may be carried out sequentially across the different IRB exposure classes within the same business unit, across different business units in the same group or for the use of own estimates of LGDs or conversion factors for the calculation of risk weights for the sovereign, institution and corporate IRB exposure class.3

[Note:BCD Article 85(1) (part)]

BIPRU 4.2.19 R

In the case of the retail exposures, implementation may (but only to the extent provided for in the firm'sIRB permission) be carried out sequentially across the categories of exposures to which the different correlations in BIPRU 4.6.41 R-BIPRU 4.6.44 R correspond.

[Note:BCD Article 85(1) (part)]

BIPRU 4.2.20 R
  1. (1)

    Implementation of the IRB approach as referred to in BIPRU 4.2.18 R must be carried out within a reasonable period of time as set out in the IRB permission.

  2. (2)

    The implementation must be carried out subject to strict conditions determined by the appropriate regulator and set out in the IRB permission.

  3. (3)

    A firm must not use the flexibility under BIPRU 4.2.18 R selectively with the purpose of achieving reduced minimum capital requirements in respect of those IRB exposure classes or business units that are yet to be included in the IRB approach or in the use of own estimates of LGDs and conversion factors.

[Note:BCD Article 85(2)]

BIPRU 4.2.21 G
  1. (1)

    A firm should achieve full roll-out of the IRB approach to all its exposures, subject to the exemptions outlined in BIPRU 4.2.26 R, within the period specified in its IRB permission. A firm should not retain a permanent mix of portfolios on the standardised approach and the IRB approach, on the foundation IRB approach and the advanced IRB approach or on a mixture of all approaches with the exception of portfolios covered by those exemptions.

  2. (2)

    This applies to a move:

    1. (a)

      from the standardised approach to the IRB approach;

    2. (b)

      from the foundation IRB approach to the advanced IRB approach; and

    3. (c)

      from the transitional rules and guidance for BIPRU to the IRB approach.

  3. (3)

    The period referred to in BIPRU 4.2.20 R (1) will generally be not more than three years of starting use of the IRB approach or the advanced IRB approach as applicable.

BIPRU 4.2.22 R

A firm using the IRB approach for any IRB exposure class must at the same time use the IRB approach for the equity exposure class.

[Note:BCD Article 85(3)]

BIPRU 4.2.23 R

Subject to BIPRU 4.2.17 R - BIPRU 4.2.20 R, BIPRU 4.2.22 R and BIPRU 4.2.26 R, a firm that has an IRB permission must not use the standardised approach for the calculation of risk weighted exposure amounts for the exposures to which the IRB approach applies under the IRB permission.

[Note:BCD Article 85(4)]1

BIPRU 4.2.24 R

Subject to BIPRU 4.2.17 R - BIPRU 4.2.22 R and BIPRU 4.2.26 R, a firm whose IRB permission provides for the use of the advanced IRB approach for the calculation of LGDs and conversion factors for the sovereign, institution and corporate IRB exposure class must not use the LGD values and conversion factors applicable to the foundation IRB approach for the exposures to which the advanced IRB approach applies under the IRB permission.

[Note:BCD Article 85(5)]

BIPRU 4.2.25 G

The appropriate regulator will not agree to a firm's request to revoke or vary its IRB permission so as to permit the firm to revert to the standardised approach except for demonstrated good cause. Likewise, the appropriate regulator will not agree to a firm's request to revoke or vary its IRB permission so as to permit the firm to revert to the foundation IRB approach if the IRB permission provides for it to use the advanced IRB approach, except for demonstrated good cause.

Combined use of methodologies: Basic provisions

BIPRU 4.2.26 R
  1. (1)

    To the extent that its IRB permission permits this, a firm permitted to use the IRB approach in the calculation of risk weighted exposure amounts and expected loss amounts3 for one or more IRB exposure classes may apply the standardised approach in accordance with this rule.

    3
  2. (2)

    A firm may apply the standardised approach to the IRB exposure class referred to in BIPRU 4.3.2 R (1) (Sovereigns) where the number of material counterparties is limited and it would be unduly burdensome for the firm to implement a rating system for these counterparties. A firm may include in this treatment an exposure of the type described in BIPRU 3.4.18 R (Exposures to churches or religious communities) that would fall within BIPRU 3.4.15 R or BIPRU 3.4.17 R (Exposure to a regional government or local authority) if those provisions had not been excluded by BIPRU 3.4.18 R.

  3. (3)

    A firm may apply the standardised approach to the IRB exposure class referred to in BIPRU 4.3.2 R (2) (Institutions), where the number of material counterparties is limited and it would be unduly burdensome for the firm to implement a rating system for these counterparties.

  4. (4)

    A firm may apply the standardised approach to exposures in non-significant business units as well as IRB exposure classes that are immaterial in terms of size and perceived risk profile.

  5. (5)

    A firm may apply the standardised approach to exposures to the central governments4 of EEA States and their4 regional governments, local authorities and administrative bodies, provided that:

    44
    1. (a)

      there is no difference in risk between the exposures to the central government and those other exposures because of specific public arrangements; and

    2. (b)

      exposures to the central government are assigned a 0% risk weight under the standardised approach.

  6. (6)

    A firm may apply the standardised approach to exposures of a firm to a counterparty which is its parent undertaking, its subsidiary undertaking or a subsidiary undertaking of its parent undertaking provided that the counterparty is an institution, a financial holding company, a mixed financial holding company,6 a financial institution, an asset management company or an ancillary services undertaking subject to appropriate prudential requirements.

  7. (7)

    A firm may apply the standardised approach to equity exposures to entities whose credit obligations qualify for a 0% risk weight under the standardised approach (including those publicly sponsored entities where a zero risk weight can be applied).

  8. (8)

    A firm may apply the standardised approach to equity exposures incurred under legislative programmes to promote specified sectors of the economy that provide significant subsidies for the investment to the firm and involve some form of government oversight and restrictions on the equity investments. This exclusion is limited to an aggregate of 10% of capital resources.

  9. (9)

    A firm may apply the standardised approach to the exposures identified in BIPRU 3.4.48 R (Exposures in the form of minimum reserves required by the European Central Bank or by the central bank of an EEA State) meeting the conditions specified therein.

  10. (10)

    A firm may apply the standardised approach to state and state-reinsured guarantees pursuant to BIPRU 5.7.12 R (Conditions for state and state-reinsured guarantees).

[Note:BCD Article 89(1)]

Combined use of methodologies: Documentation

BIPRU 4.2.27 G

As part of the application for an IRB permission, a firm should have a well documented policy explaining the basis on which exposures are to be selected for permanent exemption from the IRB approach and for treatment under the standardised approach. The firm's roll out plan should also contain provisions for the continuing application of that policy on a consistent basis over time.

Combined use of methodologies: Sovereign and institutional, exposures

BIPRU 4.2.28 G

A firm intending to make use of BIPRU 4.2.26 R (2) or BIPRU 4.2.26 R (3) should demonstrate to the appropriate regulator when applying for an IRB permission that it meets the requirements of those provisions with respect to its sovereign or, as the case may be, institutional, exposures.

Combined use of methodologies: Meaning of non-significance and immateriality

BIPRU 4.2.29 R

For the purposes of BIPRU 4.2.26 R (4), the equity exposureIRB exposure class of a firm must be considered material if its aggregate value, excluding equity exposures incurred under legislative programmes as referred to in BIPRU 4.2.26 R (8) but including exposures in a CIU treated as equity exposures in accordance with BIPRU 4.9.11 R to BIPRU 4.9.15 R,4 exceeds, on average over the preceding year, 10% of the firm'scapital resources. If the number of those equity exposures is less than 10 individual holdings, that threshold is 5% of the firm'scapital resources.

[Note:BCD Article 89(2)]

4
BIPRU 4.2.30 R
  1. (1)

    This rule sets out what must be treated as being non-significant business or immaterial for the purposes of BIPRU 4.2.26 R (4), for exposures that do not fall within the equity exposureIRB exposure class.

  2. (2)

    A firm may elect permanently to exclude exposures from the IRB approach and apply the standardised approach. However a firm may only make use of this exemption to the extent that:

    1. (a)

      the consolidated credit risk requirement (adjusted under (6)) so far as it is attributable to the excluded exposures;

    would be no more than 15% of:

    1. (b)

      the consolidated credit risk requirement (adjusted under (6)) with respect to all exposures (including the ones dealt with under (a)).

  3. (3)

    Exposures excluded under BIPRU 4.2.29 R or BIPRU 4.2.26 R (2), BIPRU 4.2.26 R (3) and BIPRU 4.2.26 R (5)-BIPRU 4.2.26 R (7) must not be included in (a) or (b).

  4. (4)

    The calculation in (2)(a) is based on the standardised approach.

  5. (5)

    The calculation in (2)(b) is based on whichever of the standardised approach and the IRB approach would apply to the exposures referred to in (2)(b) at the time when the calculation is being made.

  6. (6)

    The consolidated credit risk requirement is adjusted for the purposes of this rule as follows:

    1. (a)

      the element based on the concentration risk capital component is excluded, with only the elements based on the credit risk capital component and the counterparty risk capital component being taken into account; and

    2. (b)

      the calculation is carried out with respect to the group of undertakings referred to in BIPRU 4.2.17 R.

  7. (7)

    If a group with respect to which the calculation in this rule is being carried out is not required to calculate the consolidated credit risk requirement, the calculations in this rule must be carried out as if it were.

BIPRU 4.2.31 R

If a firm applies to use the advanced IRB approach for the sovereign, institution and corporate IRB exposure class, BIPRU 4.2.26 R (4) also applies with respect to exposures in that class. For these purposes, to the extent permitted in the firm'sIRB permission, a firm may:

  1. (1)

    exclude some exposures from the IRB approach and apply the standardised approach to those exposures; and

  2. (2)

    exclude other exposures from the advanced IRB approach and apply the foundation IRB approach to those exposures.

BIPRU 4.2.32 G

Where BIPRU 4.2.31 R applies:

  1. (1)

    the 15% limit in BIPRU 4.2.30 R (2) is a combined limit for excluded exposures remaining on the standardised approach and excluded exposures remaining on the foundation IRB approach; and

  2. (2)

    the calculation in BIPRU 4.2.30 R (2)(a) is carried out under whichever method of calculation would be applicable to the exposure in question.

Combined use of methodologies: Territorial aspects

BIPRU 4.2.33 G
  1. (1)

    7[deleted]

  2. (2)

    7[deleted]

  3. (3)

    7[deleted]

  4. (4)

    7[deleted]

    7
  5. (5)

    7[deleted]

  6. (6)

    7[deleted]

Combined use of methodologies: Intra-group exposures

BIPRU 4.2.34 G
  1. (1)

    Generally, the appropriate regulator will consider excluding, through a firm'sIRB permission, exposures falling into BIPRU 4.2.26 R (6) from the IRB approach. The degree to which this exclusion applies will be set out in the firm'sIRB permission.

  2. (2)

    Exposures excluded under (1) will be eligible for a 0% risk weight under the standardised approach if they satisfy the conditions in BIPRU 3.2.25 R to BIPRU 3.2.27A R5 (Zero risk weight for certain intra-group exposures).

    5
  3. (3)

    Exposures to or holdings in any non-financial undertakings in a firm'sgroup are not eligible for permanent exemption from the IRB approach under BIPRU 4.2.26 R (6), as they are not subject to consolidated supervision. It is also the appropriate regulator's policy that exposures to or holdings in any insurance undertaking are ineligible. Such exposures should remain on the IRB approach unless excluded under another part of BIPRU 4.2.26 R.

  4. (4)

    If a firm uses the exemption in (1) it should have a policy that:

    1. (a)

      provides for the identification of connected counterparties excluded under (1);

    2. (b)

      identifies exposures that would be permanently exempted from the IRB approach under (1); and

    3. (c)

      identifies the connected counterparty exposures that are not permitted to be permanently exempted from the IRB approach under (1).

  5. (5)

    The policy in (4) should be applied consistently to all exposures excluded under (1).

Combined use of methodologies: Purchase of a new businesses

BIPRU 4.2.35 G
  1. (1)

    This guidance deals with some possible effects of acquiring a major new business after the grant of an IRB permission.

  2. (2)

    A firm should if possible ensure that the exposures arising through the acquisition are dealt with in accordance with the firm'sIRB permission.

  3. (3)

    If the acquisition is made during the currency of a roll out plan under BIPRU 4.2.18 R, a firm should ensure that the exposures arising through the acquisition are dealt with in accordance with that plan. For these purposes the existing and the acquired business should be considered together. The whole of the firm's business, including the newly acquired business, should be included in both the denominator and numerator of the fraction in BIPRU 4.2.30 R.

  4. (4)

    If a firm cannot comply with (2) the appropriate regulator will consider an application to vary the firm'sIRB permission in order to deal with the acquisition. For example the appropriate regulator may agree to extend the time by which the roll out should be completed (see BIPRU 4.2.20 R). However any such variation should be consistent with the provisions of BIPRU 4.2 that would have applied if the acquisition had been included in the firm's original application for an IRB permission.

  5. (5)

    If the acquisition is made after a firm has completed its roll out under BIPRU 4.2.18 R the appropriate regulator will not in general agree to an application to treat an exposure:

    1. (a)

      under the standardised approach if it would otherwise be treated under the IRB approach under the firm'sIRB permission; or

    2. (b)

      under the foundation IRB approach if it would otherwise be treated under the advanced IRB approach under the firm'sIRB permission.

  6. (6)

    Any application to disapply the policy in (5) will be treated in accordance with the approach set out in BIPRU 4.2.25 G.

  7. (7)

    The appropriate regulator will also adopt the approach in (5) while a roll out plan is in progress if, in relation to an exposure of a particular type, the period for completion of the roll out for those exposures under that plan has ended.

BIPRU 4.3 The IRB approach: Provisions common to different exposure classes

Application

BIPRU 4.3.1 R

This section applies to all exposures treated under the IRB approach.

Exposure classes

BIPRU 4.3.2 R

Each exposure must be assigned to one of the following exposure classes:

  1. (1)

    claims or contingent claims on central governments and central banks;

  2. (2)

    claims or contingent claims on institutions;

  3. (3)

    claims or contingent claims on corporates;

  4. (4)

    retail claims or contingent retail claims;

  5. (5)

    equity claims;

  6. (6)

    securitisation positions; and

  7. (7)

    non credit-obligation assets.

[Note: BCD Article 86(1)]

BIPRU 4.3.3 R

The methodology used by a firm for assigning exposures to different IRB exposure classes must be appropriate and consistent over time.

[Note: BCD Article 86(9)]

Calculation of risk weighted exposure amounts

BIPRU 4.3.4 R

The risk weighted exposure amounts for credit risk for exposures belonging to one of the exposure classes referred to in (1) to (4) must, unless deducted from capital resources, be calculated in accordance with the following provisions:

  1. (1)

    for exposures in the sovereign, institution and corporate IRB exposure class, BIPRU 4.4.57 R to BIPRU 4.4.60 R, BIPRU 4.4.79 R, BIPRU 4.5.8 R to BIPRU 4.5.10 R (for specialised lending exposures), BIPRU 4.9.3 R and BIPRU 4.8.16 R to BIPRU 4.8.17 R (for purchased corporate exposure receivables);

  2. (2)

    for exposures in the retail exposureclass, BIPRU 4.6.41 R to BIPRU 4.6.44 R, BIPRU 4.6.57 R and BIPRU 4.8.18 R to BIPRU 4.8.20 R (for purchased retail exposure receivables);

  3. (3)

    for exposures in the equity exposureclass, BIPRU 4.7.5 R to BIPRU 4.7.6 R, BIPRU 4.7.9 R to BIPRU 4.7.11 R, BIPRU 4.7.14 R to BIPRU 4.7.16 R and BIPRU 4.7.24 R to BIPRU 4.7.25 R; and

  4. (4)

    for exposures in the non credit-obligation assetsexposureclass, BIPRU 4.9.6 R.

[Note: BCD Article 87(1)]

BIPRU 4.3.5 R

The calculation of risk weighted exposure amounts for credit risk and dilution risk must be based on the relevant parameters associated with the exposure in question. These include probability of default (PD), loss given default (LGD), maturity (M) and the exposure value of the exposure. PD and LGD may be considered separately or jointly, in accordance with the provisions relating to PD and LGD in BIPRU 4.4, BIPRU 4.6, BIPRU 4.7 and BIPRU 4.8 at:

  1. (1)

    for exposures in the sovereign, institution and corporate IRB exposure class, BIPRU 4.4.34 R - BIPRU 4.4.35 R, BIPRU 4.4.42 R to BIPRU 4.4.43 R, BIPRU 4.4.63 R - BIPRU 4.4.66 R, BIPRU 4.4.80 R and, for PD and LGD for dilution risk of purchased corporate exposure receivables, BIPRU 4.8.23 Rand BIPRU 4.8.26 R;

  2. (2)

    for exposures in the retail exposure class, BIPRU 4.6.50 R - BIPRU 4.6.54 R, BIPRU 4.6.58 R, and, for PD and LGD for dilution risk of purchased retail exposure receivables, BIPRU 4.8.24 R and BIPRU 4.8.27 R; and

  3. (3)

    for exposures in the equity exposure class, BIPRU 4.7.18 R and BIPRU 4.7.20 R - BIPRU 4.7.21 R.

[Note: BCD Article 87(3)]

Calculation of expected loss amounts

BIPRU 4.3.6 R

The expected loss amounts for exposures belonging to one of the IRB exposure classes referred to in (1) to (3) must be calculated in accordance with the methods set out in the following provisions:

  1. (1)

    for exposures in the sovereign, institution and corporate IRB exposure class, BIPRU 4.4.61 R to BIPRU 4.4.62 R and (for specialised lending exposures) BIPRU 4.5.13 R to BIPRU 4.5.15R;

  2. (2)

    for exposures in the retail exposure class, BIPRU 4.6.47 R to BIPRU 4.6.48 R;

  3. (3)

    for exposures in the equity exposure class, BIPRU 4.7.12 R, BIPRU 4.7.17 R and BIPRU 4.7.26 R; and

  4. (4)

    (for purchased receivables falling into one of the IRB exposure classes in (1) to (3)) BIPRU 4.8.30 R.

[Note:BCD Article 88(1)]

BIPRU 4.3.7 R

The calculation of expected loss amounts in accordance with BIPRU 4.3.6 R must be based on the same input figures of PD, LGD and the exposure value for each exposure as being used for the calculation of risk weighted exposure amounts in accordance with BIPRU 4. For defaultedexposures,where a firm uses its own estimate of LGDs, EL must be the firm's best estimate of expected loss (ELBE), for the defaultedexposure in accordance with BIPRU 4.3.122 R.

[Note:BCD Article 88(2)]

Treatment of expected loss amounts

BIPRU 4.3.8 R

The expected loss amounts calculated in accordance with BIPRU 4.3.6 R (1), BIPRU 4.3.6 R (2) and BIPRU 4.3.6 R (4) must be subtracted from the sum of value adjustments and provisions related to these exposures. Discounts on balance sheet exposures purchased when in default according to BIPRU 4.4.71 R must be treated in the same manner as value adjustments. Expected loss amounts for securitised exposures and value adjustments and provisions related to these exposures must not be included in this calculation.

[Note:BCD Annex VII Part 1 point 36]

Corporate governance

BIPRU 4.3.9 R

All material aspects of the rating and estimation processes must be approved by the firm'sgoverning body or a designated committee thereof and senior management. These parties must possess a general understanding of the firm'srating systems and detailed comprehension of its associated management reports.

[Note: BCD Annex VII Part 4 point 124]

BIPRU 4.3.10 G
  1. (1)

    A firm'sgoverning body or designated committee may choose to approve only material aspects of the firm'srating systems and material changes to the firm'srating systems.

  2. (2)

    Where a firm'sgoverning body or designated committee chooses to approve only material aspects of the firm'srating systems and material changes to the firm'srating systems:

    1. (a)

      the firm'sgoverning body or designated committee should define the firm's overall approach to material aspects of rating and estimation processes for all rating systems, including non-material rating systems and approve a policy statement defining that approach; and

    2. (b)

      the firm should define and document the process for approval of non-material aspects of the firm'srating systems.

BIPRU 4.3.11 R

Senior management must provide notice to the governing body or a designated committee thereof of material changes or exceptions from established policies that will materially impact the operations of the firm'srating systems.

[Note:BCD Annex VII Part 4 point 125]

BIPRU 4.3.12 G

Where the firm'srating systems are used on a unified basis for the parent undertaking and its subsidiary undertakings under BIPRU 4.2.3 R, and approval and reporting of the ratings systems are carried out at the group level, the governance requirements in BIPRU 4.3.9 R and BIPRU 4.3.11 R may be met if:

  1. (1)

    the subsidiary undertakings have delegated to the governing body or designated committee of the EEA parent institution or EEA parent financial holding company responsibility for approval of the firm'srating systems;

  2. (2)

    the governing body or designated committee of the EEA parent institution or EEA parent financial holding company approves either:

    1. (a)

      all aspects of the firm'srating systems, and material changes; or

    2. (b)

      all aspects of the firm'srating systems that are material in the context of the group, and material changes to those, and a policy statement defining the overall approach to material aspects of rating and estimation processes for all rating systems, including non-material rating systems.

BIPRU 4.3.13 R

Senior management must have a good understanding of the rating system's designs and operations. Senior management must ensure on an ongoing basis that the rating systems are operating properly. Senior management must be regularly informed by the credit risk control units about the performance of the rating process, areas needing improvement, and the status of efforts to improve previously identified deficiencies.

[Note:BCD Annex VII Part 4 point 126]

BIPRU 4.3.14 R

Internal ratings-based analysis of the firm's credit risk profile must be an essential part of the management reporting required under BIPRU 4.3.9 R, BIPRU 4.3.11 R and BIPRU 4.3.13 R. Reporting must include at least risk profile by grade, migration across grades, estimation of the relevant parameters per grade, and comparison of realised default rates and, to the extent that own estimates are used, of realised LGDs and realised conversion factors against expectations and stress-test results. Reporting frequencies must depend on the significance and type of information and the level of the recipient.

[Note:BCD Annex VII Part 4 point 127]

Credit risk control

BIPRU 4.3.15 R

The credit risk control unit must be independent from the personnel and management functions responsible for originating or renewing exposures and report directly to senior management. The unit must be responsible for the design or selection, implementation, oversight and performance of the rating systems. It must regularly produce and analyse reports on the output of the rating systems.

[Note:BCD Annex VII Part 4 point 128]

BIPRU 4.3.16 R

The areas of responsibility for the credit risk control unit(s) must include the following:

  1. (1)

    testing and monitoring grades and pools;

  2. (2)

    production and analysis of summary reports from the firm'srating systems;

  3. (3)

    implementing procedures to verify that grade and pool definitions are consistently applied across departments and geographic areas;

  4. (4)

    reviewing and documenting any changes to the rating process, including the reasons for the changes;

  5. (5)

    reviewing the rating criteria to evaluate if they remain predictive of risk (and changes to the rating process, criteria or individual rating parameters must be documented and retained);

  6. (6)

    active participation in the design or selection, implementation and validation of models used in the rating process;

  7. (7)

    oversight and supervision of models used in the rating process; and

  8. (8)

    ongoing review and alterations to models used in the rating process.

[Note:BCD Annex VII Part 4 point 129]

BIPRU 4.3.17 R

Notwithstanding BIPRU 4.3.16 R, a firm using pooled data according to BIPRU 4.3.92 R - BIPRU 4.3.94 R (Overall requirements for estimation) may outsource the following tasks:

  1. (1)

    production of information relevant to testing and monitoring grades and pools;

  2. (2)

    production of summary reports from the firm'srating systems;

  3. (3)

    production of information relevant to review of the rating criteria to evaluate if they remain predictive of risk;

  4. (4)

    documentation of changes to the rating process, criteria or individual rating parameters; and

  5. (5)

    production of information relevant to ongoing review and alterations to models used in the rating process.

[Note:BCD Annex VII Part 4 point 130 (part)]

BIPRU 4.3.18 R

A firm making use of BIPRU 4.3.17 R must ensure that the appropriate regulator has access to all relevant information from the third party that is necessary for examining compliance with the minimum IRB standards and the firm'sIRB permission and that the appropriate regulator may perform on-site examinations to the same extent as within the firm.

[Note:BCD Annex VII Part 4 point 130 (part)]

Documentation of rating systems

BIPRU 4.3.19 R

A firm must document the design and operational details of its rating systems. The documentation must evidence compliance with the minimum IRB standards and the firm'sIRB permission, and address topics including portfolio differentiation, rating criteria, responsibilities of parties that rate obligors and exposures, frequency of assignment reviews, and management oversight of the rating process.

[Note:BCD Annex VII Part 4 point 31]

BIPRU 4.3.20 R

A firm must ensure that all documentation relating to its rating systems or otherwise required by the rules governing the IRB approach are stored, arranged and indexed in such a way that the firm would be able to make them all available to the appropriate regulator, or to make any class or description of them specified by the appropriate regulator available to the appropriate regulator, immediately on demand or within a short time thereafter.

BIPRU 4.3.21 R

A firm must document the rationale for and analysis supporting its choice of rating criteria. A firm must document all major changes in the risk rating process, and such documentation must support identification of changes made to the risk rating process subsequent to the last review by the appropriate regulator. The organisation of rating assignment including the rating assignment process and the internal control structure must also be documented.

[Note:BCD Annex VII Part 4 point 32]

BIPRU 4.3.22 R

A firm must document the specific definitions of default and loss used internally and demonstrate consistency with the definitions of default and loss set out in the glossary and BIPRU 4.

[Note:BCD Annex VII Part 4 point 33]

BIPRU 4.3.23 G

A firm's documentation relating to data should include clear identification of responsibility for data quality. A firm should set standards for data quality and aim to improve them over time. A firm should measure its performance against those standards. A firm should ensure that its data is of high enough quality to support its risk management processes and the calculation of its capital requirements.

BIPRU 4.3.24 R

Where a firm employs statistical models in the rating process, the firm must document its methodologies. This material must:

  1. (1)

    provide a detailed outline of the theory, assumptions and/or mathematical and empirical basis of the assignment of estimates to grades, individual obligors, exposures, or pools, and the data source(s) used to estimate the model;

  2. (2)

    establish a rigorous statistical process (including out-of-time and out-of-sample performance tests) for validating the model; and

  3. (3)

    indicate any circumstances under which the model does not work effectively.

[Note:BCD Annex VII Part 4 point 34]

Rating systems

BIPRU 4.3.25 R

A rating system comprises all of the methods, processes, controls, data collection and IT systems that support the assessment of credit risk, the assignment of exposures to grades or pools (rating), and the quantification of default and loss estimates for a certain type of exposure.

[Note:BCD Annex VII Part 4 point 1]

BIPRU 4.3.26 R

If a firm uses multiple rating systems, the rationale for assigning an obligor or a transaction to a rating system must be documented and applied in a manner that appropriately reflects the level of risk.

[Note:BCD Annex VII Part 4 point 2]

BIPRU 4.3.27 R

Assignment criteria and processes must be periodically reviewed to determine whether they remain appropriate for the current portfolio and external conditions.

[Note:BCD Annex VII Part 4 point 3]

BIPRU 4.3.28 R

Where a firm uses direct estimates of risk parameters these may be seen as the outputs of grades on a continuous rating scale.

[Note:BCD Annex VII Part 4 point 4]

Validation of internal estimates

BIPRU 4.3.29 R

A firm must have robust systems in place to validate the accuracy and consistency of rating systems, processes, and the estimation of all relevant risk parameters (PD, LGD, conversion factors and EL). A firm must be able to demonstrate to the appropriate regulator that the internal validation process enables it to assess the performance of internal rating and risk estimation systems consistently and meaningfully.

[Note:BCD Annex VII Part 4 point 110]

BIPRU 4.3.30 R
  1. (1)

    A firm must validate its rating systems. Its validation process must include, as a minimum, the elements set out in (2) - (8).

  2. (2)

    A firm must establish and define standards of objectivity, accuracy, stability and conservatism that it designs its ratings systems to meet. It must have processes that establish whether its rating systems meet those standards.

  3. (3)

    A firm must establish and define standards of accuracy of calibration (i.e. whether outcomes are consistent with estimate) and discriminative power (i.e. the ability to rank-order risk) that it designs its rating systems to meet. It must have processes that establish whether its rating systems meet those standards.

  4. (4)

    A firm must have polices and standards that specify the actions to be taken when a rating system fails to meet the standards of accuracy and discriminative power referred to in (2) and (3).

  5. (5)

    A firm's validation process must include a mix of developmental evidence, benchmarking and process verification. A firm's validation process must include policies on how this mixture varies between different rating systems.

  6. (6)

    A firm's validation process must include the use of both quantitative and qualitative techniques.

  7. (7)

    A firm's validation process must include policies on how validation procedures are expected to vary over time.

  8. (8)

    A firm's validation process must include independent input into and review of its rating systems.

  9. (9)

    The standards set under (2) and (3) must meet the minimum IRB standards.

  10. (10)

    For the purpose of (5):

    1. (a)

      developmental evidence means evidence that substantiates whether the logic and quality of a rating system (including the quantification process) adequately discriminates between different levels of, and delivers accurate estimates of PD, EL, LGD and conversion factors (as applicable); and

    2. (b)

      process verification means the process of establishing whether the methods used in a rating system to discriminate between different levels of risk and to quantify PD, EL, LGD and conversion factors are being used, monitored and updated in the way intended in the design of the rating system.

BIPRU 4.3.31 G

A firm should have regard to the involvement of management at an appropriately senior level in the validation process.

BIPRU 4.3.32 G

The approach to validation may vary with the significance of the exposures covered by a rating system.

BIPRU 4.3.33 R

A firm must regularly compare realised default rates with estimated PDs for each grade and where realised default rates are outside the expected range for that grade a firm must specifically analyse the reasons for the deviation. A firm3using its own estimates of LGDs and/or conversion factors must also perform analogous analysis for own estimates of LGDs and conversion factors. Such comparisons must make use of historical data that cover as long a period as possible. A firm must document the methods and data used in such comparisons. This analysis and documentation must be updated at least annually.

[Note:BCD Annex VII Part 4 point 111]

3
BIPRU 4.3.34 G
  1. (1)

    This paragraph sets out guidance on assessing the adequacy of a rating system's discriminative power (see BIPRU 4.3.30 R (3) on the meaning of discriminative power).

  2. (2)

    A firm should be able to explain the performance of its rating systems against its chosen measure (or measures) of discriminative power. In making this comparison a firm should rely primarily on actual historic default experience where this is available. In particular, a firm should be able to explain:

    1. (a)

      the extent of any potential inaccuracy in these measures, caused in particular by small sample size; and

    2. (b)

      the potential for divergence in the future, whether caused by changing economic conditions or other factors.

  3. (3)

    The assessment of discriminative power should include appropriate use of external benchmarks where available.

  4. (4)

    The appropriate regulator will, in assessing the firm's performance, take into consideration the sophistication of the measure of discrimination chosen.

  5. (5)

    In the case of a portfolio for which there is insufficient default experience to provide any confidence in statistical measures of discriminative power a firm need not carry out the procedure in (2) and may instead use other methods. For example, it may make use of comparison with an external measurement approach by analysing whether the firm'srating systems and the external approach rank common obligors in broadly similar ways. A firm should be able to explain the methodology it uses and the rationale for its use.

BIPRU 4.3.35 R

A firm must also use other appropriate quantitative validation tools and comparisons with relevant external data sources. The analysis must be based on data that is appropriate to the portfolio, is updated regularly, and covers a relevant observation period. A firm's internal assessments of the performance of its rating systems must be based on as long a period as possible.

[Note:BCD Annex VII Part 4 point 112]

BIPRU 4.3.36 R

The methods and data used for quantitative validation must be consistent through time. Changes in estimation and validation methods and data (both data sources and periods covered) must be documented.

[Note:BCD Annex VII Part 4 point 113

BIPRU 4.3.37 R

A firm must have sound internal standards for situations where deviations in realised PDs, LGDs, conversion factors and, where EL is used, total losses, 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 and loss experience. Where realised values continue to be higher than expected values, a firm must revise estimates upward to reflect its default and loss experience.

[Note:BCD Annex VII Part 4 point 114]

Internal audit

BIPRU 4.3.38 R

Internal audit or another comparable independent auditing unit must review at least annually the firm'srating systems and its operations, including the operations of the firm and the estimation of PDs, LGDs, ELs and conversion factors. Areas of review must include adherence to all applicable minimum requirements.

[Note:BCD Annex VII Part 4 point 131]

Stress tests used in assessment of capital adequacy

BIPRU 4.3.39 R

A firm must have in place sound stress testing processes for use in the assessment of its capital adequacy. Stress testing must involve identifying possible events or future changes in economic conditions that could have unfavourable effects on the firm's credit exposures and assessment of the firm's ability to withstand such changes.

[Note:BCD Annex VII Part 4 point 40]

BIPRU 4.3.39A G

4The appropriate regulator expects that firms will routinely make use of stress testing and scenario analysis as a tool in the calibration and/or validation of their IRB approach parameters in order to increase the accuracy or, at least, the conservatism of the estimates. Stress testing should include a thorough exploration of various outturns different to the firm's normal expectations in order to give the firm a clear view of the potential for the forward-looking estimate to be different from that indicated by the primary data source(s). Firms should consider this as an integral part of their quantification process, and should have clear standards for how the results of the stress tests affect the final estimates used for the IRB approach parameters.

BIPRU 4.3.40 R
  1. (1)

    A firm must regularly perform a credit risk stress test to assess the effect of certain specific conditions on its total capital requirements for credit risk. The test to be employed must be one chosen by the firm. The test to be employed must be meaningful and reasonably conservative. Stressed portfolios must contain the vast majority of a firm's total exposures covered by the IRB approach.

  2. (2)

    The stress test must be designed to assess the firm's ability to meet its capital requirements for credit risk under GENPRU 2.1 during all stages of the economic cycle and during an economic downturn scenario based on forward looking hypothetical events calibrated against the most adverse movements in individual risk drivers experienced over a long historical period.4

    4
  3. (3)

    In particular the stress test must address the impact (including by ratings migration) of changes in the credit quality of its credit risk counterparties including its protection providers. A firm using the treatment set out in BIPRU 4.4.79 R must in particular consider the impact of protection providers falling outside the eligibility criteria.

  4. (4)

    The stress test must be conducted on the basis of the firm'sexposures (on- and off-balance sheet) as they stand at the time of the stress test.

  5. (5)

    The stress test must be carried out at least annually and also in the event of a significant change in the state of the economy.

  6. (6)

    A firm need not assume that the recession referred to in (2) will occur in the 12 months immediately following the stress test. Instead, the stress test must incorporate a plausible time horizon for the occurrence of the cyclical deterioration of the severity tested for. A firm need not assume that the downturn will occur for all portfolios in all jurisdictions simultaneously.

[Note:BCD Annex VII Part 4 points 41 and 42]

BIPRU 4.3.41 G

To the extent that the economic conditions assumed in the stress tests required under BIPRU 4.3.39 R or BIPRU 4.3.40 R coincide with the conditions assumed in the production of economic downturn LGDs (see BIPRU 4.3.103 R), the LGDs to be used might be expected to be similar.

BIPRU 4.3.42 G

The requirement in BIPRU 4.3.40 R (2) is to identify, in a forward-looking manner, severe but plausible downturn conditions relevant to business lines and jurisdictions and to determine the likely impact of those conditions on a firm's credit risk regulatory capital requirements. The description of the economic recession contained in BIPRU 4.3.40 R (2) should not be taken as stipulating one approach (e.g. statistical) over other approaches (e.g. scenario analysis) in the identification of the relevant recessionary circumstances.

Rating systems: Assignment to grades or pools

BIPRU 4.3.43 R

A firm must have specific definitions, processes and criteria for assigning exposures to grades or pools within a rating system.

[Note:BCD Annex VII Part 4 point 17 (part)]

BIPRU 4.3.44 R

The grade or pool definitions and criteria must be sufficiently detailed to allow those charged with assigning ratings consistently to assign obligors or facilities posing similar risk to the same grade or pool. This consistency must exist across lines of business, departments and geographic locations within each rating system.

[Note:BCD Annex VII Part 4 point 17 (part)]

BIPRU 4.3.45 G

In meeting BIPRU 4.3.44 R a firm should have regard to its application to each rating system.

BIPRU 4.3.46 R

The documentation of the rating process must allow third parties to understand the assignments of exposures to grades or pools, to replicate grade and pool assignments and to evaluate the appropriateness of the assignments to a grade or a pool.

[Note:BCD Annex VII Part 4 point 17 (part)]

BIPRU 4.3.47 R

The criteria referred to in BIPRU 4.3.43 R must also be consistent with the firm's internal lending standards and its policies for handling troubled obligors and facilities.

[Note:BCD Annex VII Part 4 point 17 (part)]

BIPRU 4.3.48 R

A firm must take all relevant information into account in assigning obligors and facilities to grades or pools. Information must be current and must enable the firm to forecast the future performance of the exposure. The less information a firm has, the more conservative must be its assignments of exposures to obligor and facility grades or pools. If a firm uses an external rating as a primary factor determining an internal rating assignment, the firm must ensure that it considers other relevant information.

[Note:BCD Annex VII Part 4 point 18]

Rating systems: General governance

BIPRU 4.3.49 G
  1. (1)

    This paragraph contains guidance on BIPRU 4.3.43 R and more general guidance about the governance of rating systems.

  2. (2)

    In determining the assignment referred to in BIPRU 4.3.43 R, a firm should have regard to the sensitivity of the rating to movements in fundamental risk drivers.

  3. (3)

    A firm should, for any rating system, be able to demonstrate that it acts appropriately or has an appropriate policy, as applicable, with respect to:

    1. (a)

      any deficiencies caused by its not being sensitive to movements in fundamental risk drivers or for any other reason;

    2. (b)

      periodic review and action in the light of such review;

    3. (c)

      provision of appropriate internal guidance to staff to ensure consistency in the use of the rating system, including the assignment of exposures or facilities to pools or grades;

    4. (d)

      dealing with potential weaknesses of the rating system;

    5. (e)

      identifying appropriate and inappropriate uses of the rating system and acting on that identification;

    6. (f)

      novel or narrow rating approaches; and

    7. (g)

      ensuring the appropriate level of stability over time of the rating system.

Rating systems: Overrides

BIPRU 4.3.50 R

For grade and pool assignments a firm must document the situations in which human judgement may override the inputs or outputs of the assignment process and the personnel responsible for approving these overrides. A firm must document these overrides and the personnel responsible. A firm must analyse the performance of the exposures whose assignments have been overridden. This analysis must include assessment of the performance of exposures whose rating has been overridden by a particular person, accounting for all the responsible personnel.

[Note:BCD Annex VII Part 4 point 25]

Rating systems: Use of models

BIPRU 4.3.51 R
  1. (1)

    This paragraph applies to the use of statistical models and/or other mechanical methods to assign exposures to obligor grades, obligor pools, facility grades or facility pools.

  2. (2)

    A firm must be able to demonstrate to the appropriate regulator that the model has good predictive power and that capital requirements are not distorted as a result of its use.

  3. (3)

    The input variables to the model must form a reasonable and effective basis for the resulting predictions. The model must not have material biases.

  4. (4)

    A firm must have in place a process for vetting data inputs into the model, which includes an assessment of the accuracy, completeness and appropriateness of the data.

  5. (5)

    A firm must be able to demonstrate to the appropriate regulator that the data used to build the model is representative of the population of the firm's actual obligors or exposures.

  6. (6)

    A firm must have a regular cycle of model validation that includes monitoring of model performance and stability, review of model specification and testing of model outputs against outcomes.

  7. (7)

    A firm must complement the statistical model by human judgement and human oversight to review model-based assignments and to ensure that the models are used appropriately. Review procedures must aim at finding and limiting errors associated with model weaknesses. Human judgements must take into account all relevant information not considered by the model. A firm must document how human judgement and model results are to be combined.

  8. (8)

    Use of a model obtained from a third-party vendor that claims proprietary technology is not a justification for exemption from documentation or any other of the requirements in BIPRU 4 or a firm'sIRB permission for rating systems. A firm must be able to satisfy the appropriate regulator that all those requirements are satisfied if it uses such a model.

[Note:BCD Annex VII Part 4 points 30 and 35 (part)]

BIPRU 4.3.52 G
  1. (1)

    This paragraph contains guidance on BIPRU 4.3.51 R (7).

  2. (2)

    BIPRU 4.3.51 R (7) does not require that each individual assignment of an exposure to a pool or grade should be the subject of an open-ended review by reference to factors not covered by the model if:

    1. (a)

      that is not necessary in order to meet the requirements of BIPRU 4 about the ability of the rating system to predict and to discriminate (as referred to in BIPRU 4.3.29 R to BIPRU 4.3.30 R (Validation of internal estimates)); and

    2. (b)

      the outputs of the model are not designed to be supplemented by such a review.

BIPRU 4.3.53 G
  1. (1)

    This paragraph contains guidance on BIPRU 4.3.51 R for the use of external models.

  2. (2)

    BIPRU 4.3.51 R (2) - BIPRU 4.3.51 R (8) also apply to mechanical methods to assign exposures or obligors to facility grades or pools and to a combination of models and mechanical methods.

  3. (3)

    The standards which a firm applies to an external model should not be lower than those for internal models.

  4. (4)

    The appropriate regulator will not accredit any individual model or vendor. The burden is on a firm to satisfy itself that external models are fit for purpose and meet the relevant requirements of the IRB approach.

  5. (5)

    Notwithstanding that commercial confidentiality may limit the willingness of vendors of external models to disclose all details, a firm should ensure that it is able to obtain sufficiently detailed information to be able to satisfy the requirements of the IRB approach.

  6. (6)

    A firm should have a clear understanding of responsibilities for support and maintenance of external models. This should include how new developments will be brought in and what entitlement the firm has to receive and/or request specific enhancements. A firm should ensure that the requirements of BIPRU 4.3.51 R and other provisions of the IRB approach are complied with on an ongoing basis.

  7. (7)

    If a firm uses an external model it should have regard to the following:

    1. (a)

      the adequacy of the information it has about the population on which the model is built;

    2. (b)

      the comparability of the population referred to in (a) to the exposures with respect to which it is using that model;

    3. (c)

      what the drivers of the model are and their relevance to the exposures with respect to which it is using the model; and

    4. (d)

      how the firm satisfies itself that the standards required by the IRB approach for an internal model are met by the external model.

Rating systems: Data maintenance

BIPRU 4.3.54 R

A firm must collect and store data on aspects of its internal ratings as required under BIPRU 11 (Disclosure).

[Note:BCD Annex VII Part 4 point 36]

Rating systems: IT systems

BIPRU 4.3.55 G

A firm should ensure that IT systems relevant to the operation of its rating systems are sound and robust. A firm's IT systems should provide rapid availability of databases and appropriate archiving. Adequate controls should be in place to prevent unauthorised changes to data being made. Contingency processes and plans should be in place to deal with events of system failure. A firm should document work-flows and procedures related to data collection and storage.

Definition of default: Main provisions

BIPRU 4.3.56 R

A default must be considered to have occurred with regard to a particular obligor when either or both of the two following events has taken place:

  1. (1)

    the firm considers that the obligor is unlikely to pay its credit obligations to the firm, the parent undertaking or any of its subsidiary undertakings in full, without recourse by the firm to actions such as realising security (if held); and

  2. (2)

    the obligor is past due more than 90 days on any material credit obligation to the firm, the parent undertaking or any of its subsidiary undertakings.

[Note:BCD Annex VII Part 4 point 44 (part)]

BIPRU 4.3.57 R

The following provisions also apply with respect to the definition of default:

  1. (1)

    for overdrafts, days past due commence once an obligor has breached an advised limit, has been advised a limit smaller than current outstandings, or has drawn credit without authorisation and the underlying amount is material;

  2. (2)

    an advised limit means a limit which has been brought to the knowledge of the obligor;

  3. (3)

    days past due for credit cards commence on the minimum payment due date;

  4. (4)

    in the case of retail exposures and exposures to public sector entities the number of days past due is as set out in BIPRU 4.4.22 R and BIPRU 4.6.20 R; and

  5. (5)

    in all cases for the purposes of the definition of default, a credit obligation or, for overdrafts, the underlying amount, is material if, when added to the other exposures of the obligor, the total exceeds the amount which the firm treats as a material default for its internal risk measurement and management purposes.

[Note:BCD Annex VII Part 4 point 44 (part)]

Definition of default: Materiality

BIPRU 4.3.58 R

Where a firm applies the definition of default at facility level in accordance with BIPRU 4.6.21 R, it should define materiality for the purposes of BIPRU 4.3.57 R (5) by reference to the facility amount only, disregarding other exposures of the obligor.

BIPRU 4.3.59 R

A firm must have a policy which sets out how it will determine whether a credit obligation or, for overdrafts, the underlying amount, is material for the purposes of the definition of default in BIPRU 4.3.56 R (2) and BIPRU 4.3.57 R (5).

Definition of default: Identification of obligor

BIPRU 4.3.60 G
  1. (1)

    This paragraph contains guidance on the definition of default.

  2. (2)

    If:

    1. (a)

      a firm ordinarily assigns exposures in the sovereign, institution and corporate IRB exposure class to a member of a group substantially on the basis of membership of that group and a common group rating; and

    2. (b)

      the firm does so in the case of a particular group;

  3. (3)

    the firm should consider whether members of that group should be treated as a single obligor for the purpose of the definition of default.

  4. (4)

    The appropriate regulator would not expect a firm to treat an obligor as part of a single obligor under (2) if the firm rates its exposures on a stand alone basis or if its rating is notched. A rating is notched if it takes into account individual risk factors or otherwise reflects risk factors that are not applied on a common group basis.

  5. (5)

    Accordingly if a group has two members who are separately rated the default of one does not necessarily imply the default of the other.

Definition of default: Days past due

BIPRU 4.3.61 G
  1. (1)

    This paragraph contains guidance on the meaning of days past due for the purposes of the definition of default.

  2. (2)

    If an amount is overdue by the relevant number of days past due because of administrative oversight on the part of the obligor or the firm, a firm with sufficient information may, retrospectively if necessary, treat that as not involving a default if:

    1. (a)

      that failure is not associated with any increase in the risk referred to in BIPRU 4.3.56 R (1); and

    2. (b)

      treating it as not being in default is consistent with the way that the firm treated the failure in its relationship with the obligor.

  3. (3)

    If a firm takes advantage of this provision it should have a policy about the circumstances in which it can apply the treatment in (2). That policy should be documented and consistently applied.

BIPRU 4.3.62 G

Days past due is only one part of the definition of default and should be treated as a back-stop. A firm should not rely solely on the number of days past due set by BIPRU 4 but should also consider all other indicators of unlikeliness to pay when assessing whether a default has occurred.

Definition of default: Unlikeliness to pay

BIPRU 4.3.63 R
  1. (1)

    Elements to be taken as indications of unlikeliness to pay must include the items set out in this rule.

  2. (2)

    The firm putting the credit obligation on non-accrued status must be taken as an indication of unlikeliness to pay.

  3. (3)

    The firm making a value adjustment resulting from a significant perceived decline in credit quality subsequent to the firm taking on the exposure must be taken as an indication of unlikeliness to pay.

  4. (4)

    The firm selling the credit obligation at a material credit-related economic loss must be taken as an indication of unlikeliness to pay.

  5. (5)

    The firm consenting to a distressed restructuring of the credit obligation must be taken as an indication of unlikeliness to pay where this is likely to result in a diminished financial obligation caused by the material forgiveness, or postponement, of principal, interest or (where relevant) fees. This includes in the case of equity exposures assessed under a PD/LGD approach, distressed restructuring of the equity itself.

  6. (6)

    The firm having filed for the obligor's bankruptcy or a similar order in respect of an obligor's credit obligation to the firm, the parent undertaking or any of its subsidiary undertakings must be taken as an indication of unlikeliness to pay.

  7. (7)

    The obligor seeking or having been placed in bankruptcy or similar protection where this would avoid or delay repayment of a credit obligation to the firm, the parent undertaking or any of its subsidiary undertakings must be taken as an indication of unlikeliness to pay.

[Note:BCD Annex VII Part 4 point 45]

BIPRU 4.3.64 G

A firm may use the amount overdue as an additional indication of unlikeliness to pay. If a firm uses this approach, the days past due element of the definition of default continues to apply, including the provisions relating to the fixed number of days past due referred to in BIPRU 4.3.57 R (4). A firm might make the use of a definition of default that takes into account the amount overdue consistent with the days past due element of the definition by setting the amount overdue at such a level that, taking into account:

  1. (1)

    the order in which payments are applied against overdue payments; and

  2. (2)

    the number of payment dates, the time between them, the amount of the overdue payments that results in a default under the definition used by the firm and other relevant factors;

it is not possible for any payment to be past due by a number of days exceeding the maximum amount specified in BIPRU for the purposes of the definition of default without there being a default under the part of the definition of default based on the amount overdue.

BIPRU 4.3.65 G

In the case of a retail exposure, a value adjustment resulting from significant perceived decline in credit quality falling within BIPRU 4.3.63 R (3) need not necessarily be taken as an indication of unlikeliness to pay if a firm employs formulaic portfolio provisioning based on a number of days overdue for its retail exposures. However, if such an exposure reaches the compulsory days past due indicator for the purposes of the definition of default it should automatically be deemed to be in default, regardless of the provisioning situation.

BIPRU 4.3.66 G

An obligation should be considered a distressed restructuring under BIPRU 4.3.63 R (5) if an independent third party, with expertise in the relevant area, would not be prepared to provide financing on substantially the same terms and conditions.

BIPRU 4.3.67 G
  1. (1)

    The realisation or forfeiture of collateral may be taken as an indication of unlikeliness to pay for the purposes of the definition of default.

  2. (2)

    However, the realisation or forfeiture of collateral may not indicate unlikeliness to pay:

    1. (a)

      in the case of an exposure in a market (such as one that involves retail exposures involving margin lending) in which it is established practice for collateral to be sold if its value falls below a certain percentage of the exposure and the obligor does not restore the margin (but this exception does not apply if the value of the collateral has fallen below the amount outstanding); or

    2. (b)

      if the firm is able to demonstrate that for some other reason the realisation or forfeiture of collateral is not a meaningful indication of unlikeliness to pay.

BIPRU 4.3.68 G
  1. (1)

    If an obligor approach is being taken with respect to retail exposures (that is, the application of the definition of default at an obligor level rather than at a facility level as set out in BIPRU 4.6.21 R,) a firm should ensure that the PD associated with unsecured exposures is not understated as a result of the presence of any collateralised exposures. A firm should be able to explain to the appropriate regulator, if asked, how it has ensured that its estimate of PD is appropriate for both secured and unsecured exposures covered by an obligor rating approach.

  2. (2)

    In the view of the appropriate regulator, firms typically find that the PD of a residential mortgage is lower than the PD of an unsecured loan to the same borrower.

BIPRU 4.3.69 G

A firm may, but without prejudice to BIPRU 4.4.22 R and BIPRU 4.6.20 R (Fixed numbers of days past due), use additional, or stricter, indicators of unlikeliness to pay if it uses these indicators for internal purposes in accordance with BIPRU 4.2.2 R (2) (Use tests) and if the disclosures under BIPRU 11 (Disclosure) are on this basis.

Risk quantification: Definition of default: Other provisions

BIPRU 4.3.70 R

A firm must (if it uses external data that is not itself consistent with the definition of default) be able to demonstrate to the appropriate regulator that appropriate adjustments have been made that achieve broad equivalence with the definition of default.

[Note:BCD Annex VII Part 4 point 46]

BIPRU 4.3.71 R

If a firm considers that a previously defaultedexposure is such that no trigger of default continues to apply, the firm must rate the obligor or facility as it would for a non-defaultedexposure. Should the definition of default subsequently be triggered, another default must be deemed to have occurred.

[Note:BCD Annex VII Part 4 point 47]

BIPRU 4.3.72 G

A firm should have a clear and documented policy for determining whether an exposure that has been in default should subsequently be returned to performing status.

Risk quantification: Overall requirements for estimation: General

BIPRU 4.3.73 R

BIPRU 4.3.74 R to BIPRU 4.3.131 R apply to a firm's own estimates of risk parameters used in the IRB approach.

[Note:BCD Annex VII Part 4 point 43]

BIPRU 4.3.74 R

A firm's own estimates of the risk parameters PD, LGD, conversion factor and EL must incorporate all relevant data, information and methods. The estimates must be derived using both historical experience and empirical evidence, and must not be based purely on judgemental considerations. The estimates must be plausible and intuitive and must be based on the material drivers of the respective risk parameters. The less data a firm has, the more conservative it must be in its estimation.

[Note:BCD Annex VII Part 4 point 49]

BIPRU 4.3.75 G
  1. (1)

    This paragraph provides guidance on BIPRU 4.3.73 R.

  2. (2)

    Relevant data and information under BIPRU 4.3.73 R includes external data.

  3. (3)

    Where internal default and loss experience is scarce, a firm should consider using material relevant external information. When using external information such as industry averages when determining LGD or conversion factors, a firm should consider whether this data is appropriate to its own experience and whether adjustments are necessary.

BIPRU 4.3.76 R
  1. (1)

    In calculating estimates of PD, LGD and conversion factors a firm must adjust the averages of historical experience referred to in the historical averages rules in order to ensure that those estimates are accurate estimates of the default rate, loss rate or conversion factor over the long-run.

  2. (2)

    The historical average rules means the requirements in BIPRU 4 relating to the calculation of PD, LGD and conversion factors using historical averages (and in particular BIPRU 4.4.24 R, BIPRU 4.4.30 R, BIPRU 4.8.7 R, BIPRU 4.8.8 R, BIPRU 4.6.24 R, BIPRU 4.6.27 R, BIPRU 4.3.99 R and BIPRU 4.3.125 R).

BIPRU 4.3.77 G

Where a firm is able to demonstrate that the effect is immaterial in accordance with BIPRU 4.1.25 R (Compliance), it may estimate average LGDs and conversion factors under the historical average rules in a way that does not strictly comply with BIPRU 4.3.94 R (Default weighted average), provided the final estimates of LGD and conversion factors following the adjustments to averages of historical experience are made on the basis of default weighted averages for the facility grade or pool2 in question.

BIPRU 4.3.78 G

A firm may carry out the adjustments under BIPRU 4.3.76 R (Adjustments to averages of historical experience) by adjusting the data from which estimates are made rather than by adjusting the estimates themselves if it can demonstrate that capital requirements are not underestimated as a result.

BIPRU 4.3.79 G

While the qualitative requirements in BIPRU 4 are important for all portfolios, they are of even greater importance in those cases where a firm lacks sufficient historical data to calibrate or validate its estimates of PD, LGD or conversion factors on the basis of proven statistical significance, sometimes referred to as low default portfolios.

BIPRU 4.3.80 R
  1. (1)

    A firm must collect data on what it considers to be the main drivers of the risk parameters PD, LGD, conversion factor and EL for each group of obligors or facilities.

  2. (2)

    A firm must document its identification of the main drivers of risk parameters.

  3. (3)

    A firm must be able to demonstrate that its process of identification is reasonable and appropriate.

BIPRU 4.3.81 R

In its processes for identifying the main drivers of risk parameters, a firm must set out its reasons for concluding that the data sources chosen provide in themselves sufficient discriminative power and accuracy and why additional potential data sources do not provide relevant and reliable information that would be expected materially to improve the discriminative power and accuracy of its estimates of the risk parameter in question. This does not require an intensive analysis of all factors.

BIPRU 4.3.82 G

If a firm uses a rating model to assign exposures to the borrower or facility grades, it may reflect the data on main drivers of risk parameters by its inclusion in the model as a risk driver or as part of a subsequent process that adjusts the output of that model to calculate the risk parameters PD, LGD, conversion factor and EL.

BIPRU 4.3.83 R

A firm must be able to provide a breakdown of its loss experience in terms of default frequency, LGD, conversion factor, or loss where EL estimates are used, by the factors it sees as the drivers of the respective risk parameters. A firm must be able to demonstrate to the appropriate regulator that its estimates are representative of long-run experience.

[Note:BCD Annex VII Part 4 point 50]

BIPRU 4.3.84 R

Any changes in lending practice or the process for pursuing recoveries over the observation periods referred to in BIPRU 4.4.31 R (Observation period for sovereigns, institutions and corporates for PDs), BIPRU 4.6.28 R (Observation period for retail exposures for PDs), BIPRU 4.4.54 R (Observation period for sovereigns, institutions and corporates for LGDs), BIPRU 4.6.33 R (Observation period for retail exposures for LGDs), BIPRU 4.4.55 R (Observation period for sovereigns, institutions and corporates for conversion factors) and BIPRU 4.6.38 R (Observation period for retail exposures for conversion factors) must be taken into account. A firm's estimates must reflect the implications of technical advances and new data and other information, as it becomes available. A firm must review its estimates when new information comes to light but at least on an annual basis.

[Note:BCD Annex VII Part 4 point 51]

BIPRU 4.3.85 R

The population of exposures represented in the data used for estimation, the lending standards used when the data was generated and other relevant characteristics must be comparable with those of a firm'sexposures and standards. A firm must also be able to demonstrate to the appropriate regulator that the economic or market conditions that underlie the data are relevant to current and foreseeable conditions. The number of exposures in the sample and the data period used for quantification must be sufficient to provide a firm with confidence in the accuracy and robustness of its estimates.

[Note:BCD Annex VII Part 4 point 52]

BIPRU 4.3.86 G

It may be reasonable for a firm to treat foreseeable in BIPRU 4.3.85 R as referring to the most distant date to which it carries out detailed capital planning.

BIPRU 4.3.87 G

A firm should be able to demonstrate to the appropriate regulator:

  1. (1)

    how, with respect to each rating system, both assignment of ratings and estimates of PD, LGD and conversion factors are affected by:

    1. (a)

      movements in the economic cycle; and

    2. (b)

      other cyclical effects which are material to levels of default, loss or the amount of exposures at default for the exposures covered by the rating system; and

  2. (2)

    the level of conservatism inherent in its ratings, as provided for by BIPRU.

BIPRU 4.3.88 R

A firm must add to its estimates a margin of conservatism that is related to the expected range of estimation errors. Where methods and data are less satisfactory and the expected range of errors is larger, the margin of conservatism must be larger.

[Note:BCD Annex VII Part 4 point 54]

BIPRU 4.3.89 G

Estimation of PD through the use of a technique set out in BIPRU does not remove the need to make conservative adjustments, where necessary, related to the expected range of estimation errors so that capital requirements produced by the relevant model or other rating system are not understated.

BIPRU 4.3.90 R

If a firm uses different estimates for the calculation of risk weights and internal purposes it must be documented. The firm must be able to demonstrate to the appropriate regulator the reasonableness of such estimates.

[Note:BCD Annex VII Part 4 point 55]

BIPRU 4.3.91 G

If a firm can demonstrate to the appropriate regulator that for data that has been collected prior to 31 December 2006, appropriate adjustments have been made to achieve broad equivalence with the definitions of default or loss, the appropriate regulator may in the IRB permission allow the firm some flexibility in the application of the required standards for data.

[Note:BCD Annex VII Part 4 point 56]

Risk quantification: Overall requirements for estimation: Pooled data

BIPRU 4.3.92 R

If a firm uses data that is pooled across institutions it must be able to demonstrate to the appropriate regulator that:

  1. (1)

    the rating systems and criteria of other firms in the pool are similar to its own;

  2. (2)

    the pool is representative of the portfolio for which the pooled data is used; and

  3. (3)

    the pooled data is used consistently over time by the firm for its permanent estimates.2

[Note:BCD Annex VII Part 4 point 57]

BIPRU 4.3.93 G

BIPRU 4.3.92 R (1) is intended to ensure that data entering a pool is consistent and does not contain distortions as a result of different contributors' practices. It is not intended to constrain the use of pooled data by one firm that is contributed by a second firm where the differences do not affect the data being contributed.

BIPRU 4.3.94 R

If a firm uses data that is pooled across institutions it remains responsible for the integrity of its rating systems. If a firm uses such data it must be able to demonstrate to the appropriate regulator that it has sufficient in-house understanding of its rating systems, including effective ability to monitor and audit the rating process.

[Note:BCD Annex VII Part 4 point 58]

Risk quantification: Overall requirements for estimation: Requirements specific to PD estimates

BIPRU 4.3.95 R
  1. (1)

    If:

    1. (a)

      a firm's internal experience of exposures of a type covered by a model or other rating system is 20 defaults or fewer; and

    2. (b)

      in the firm's view, reliable estimates of PD cannot be derived from external sources of default data, including the use of market price related data, for all the exposures covered by the rating system;

    the firm must estimate PD for exposures covered by that rating system in accordance with this rule.

  2. (2)

    A firm must use a statistical technique to derive the distribution of defaults implied by the firm's experience, estimating PDs (the "statistical PD") from the upper bound of a confidence interval set by the firm in order to produce conservative estimates of PDs in accordance with BIPRU 4.3.88 R.

  3. (3)

    The techniques chosen for the purposes of (2) must take account, as a minimum, of the following modelling issues:

    1. (a)

      the number of defaults and number of obligor years in the sample;

    2. (b)

      the number of years from which the sample was drawn;

    3. (c)

      the interdependence between default events for individual obligors;

    4. (d)

      the interdependence between default rates for different years; and

    5. (e)

      the choice of the statistical estimators and the associated distributions and confidence intervals.

  4. (4)

    The firm must further adjust the statistical PD to the extent necessary to take account of the following:

    1. (a)

      any likely differences between the observed default rates over the period covered by the firm'sdefault experience and the long-run PD for each grade in accordance with BIPRU 4.4.24 R and BIPRU 4.6.24 R; and

    2. (b)

      any other information that indicates (taking into account the robustness and cogency of that information) that the statistical PD is likely to be an inaccurate estimate of PD.

  5. (5)

    This rule is in addition to the other requirements in BIPRU about the calculation of PD.

  6. (6)

    When a firm calculates whether it has 20 defaults or fewer under the calculation in (1)(a), it must only take into account defaults that occurred during periods that are relevant to the validation under BIPRU 4 of the model or other rating system in question.

BIPRU 4.3.96 G

A firm may if appropriate also choose to use the approach in BIPRU 4.3.91 G if the internal experience on exposures covered by a rating system is greater than 20 defaults.

BIPRU 4.3.97 G

If a firm excludes defaultedexposures that have been cured (as referred to in BIPRU 4.3.71 R) or restructured (as referred to in BIPRU 4.3.63 R (5)) from estimates of LGD in accordance with BIPRU 4.3.110 G, it may also exclude cures from estimates of PD for these exposures1.

Risk quantification: Overall requirements for estimation: Requirements specific to own-LGD estimates

BIPRU 4.3.98 R

BIPRU 4.3.98 R to BIPRU 4.3.123 R set out requirements specific to own-LGD estimates.

BIPRU 4.3.99 R

A firm must estimate LGDs by facility grade or pool on the basis of the average realised LGDs by facility grade or pool using all observed defaults within the data sources (default weighted average).

[Note:BCD Annex VII Part 4 point 73]

BIPRU 4.3.100 R

A firm must calculate the default weighted average on the basis of the number of defaults included in the calculations made under the historical average rules so far as they relate to the calculation of PDs and must not be weighted by the size of exposures.

BIPRU 4.3.101 R
  1. (1)

    A firm's estimates of LGDs must take into account:

    1. (a)

      data in respect of relevant incomplete workouts; and

    2. (b)

      the possibility that the proportion of defaultedexposures which are cured (as referred to in BIPRU 4.3.71 R) or restructured (as referred to in BIPRU 4.3.63 R (5)) or the length of the period over which a firm makes recoveries under a defaultedexposure may be different from the firm's observed historic experience.

  2. (2)

    An incomplete workout as referred to in (1)(a) means a defaultedexposure included in the data set on which the firm'sLGD estimates are based, but for which the recovery process is still in progress, with the result that the final realised losses in respect of that exposure are not yet certain.

BIPRU 4.3.102 G

The changes referred to in BIPRU 4.3.101 R (1)(b) may be caused by external factors, such as the economic environment, as well as factors specific to the obligor, the transaction or the policies of the firm.

BIPRU 4.3.103 R

A firm must use LGD estimates that are appropriate for an economic downturn if those are more conservative than the long-run average. To the extent a rating system is expected to deliver constant realised LGDs by grade or pool over time, a firm must make adjustments to its estimates of risk parameters by grade or pool to limit the capital impact of an economic downturn.

[Note:BCD Annex VII Part 4 point 74]

BIPRU 4.3.104 R
  1. (1)

    A firm must have a rigorous and well documented process for:

    1. (a)

      assessing the effects, if any, of economic downturn conditions on recovery rates; and

    2. (b)

      producing LGD estimates consistent with downturn conditions as referred to in BIPRU 4.3.103 R.

  2. (2)

    That process must include the following, which may be included in an integrated manner:

    1. (a)

      identification of appropriate downturn conditions for each IRB exposure class within each jurisdiction;

    2. (b)

      identification of adverse dependencies, if any, between default rates and recovery rates; and

    3. (c)

      incorporation of adverse dependencies, if identified, between default rates and recovery rates in the firm's estimates of LGD in a manner that meets the requirements in BIPRU 4.3.103 R relating to an economic downturn.

BIPRU 4.3.105 G

A firm may derive the LGD in accordance with BIPRU 4.3.104 R (2)(c) either by directly assigning to the facility grade or pool an estimate of LGD appropriate for downturn conditions, or alternatively by estimating a default weighted average LGD in accordance with BIPRU 4.3.99 R and BIPRU 4.3.76 R and converting it into an LGD appropriate for downturn conditions by the use of a formula. It should be able to demonstrate that that formula produces well-founded estimates of LGDs consistent with downturn conditions for the exposures in question.

BIPRU 4.3.106 G

A firm may combine IRB exposure classes, jurisdictions or both for the purpose of BIPRU 4.3.104 R (2)(a) if it can demonstrate that the downturn conditions to which the portfolios are subject will be similar.

BIPRU 4.3.107 G

The adverse dependencies referred to in BIPRU 4.3.104 R (2)(b) will not always exist. However, if a firm uses LGDs that do not allow for such adverse dependencies, it should be able to justify its decision.

BIPRU 4.3.108 G

Data relating to economic downturn conditions is likely to be scarce. Accordingly, a firm should use internal data, external data or a combination of data sources in order to produce appropriate downturn LGD estimates in accordance with BIPRU 4.3.103 R.

BIPRU 4.3.109 R

A firm must retain sufficient data on both LGDs calculated on a economic downturn basis and calculated on a long-run average basis (as referred to in BIPRU 4.3.103 R) to be able to demonstrate to the appropriate regulator (if asked) that its estimates based on an economic downturn are no less conservative than the long-run average as referred to in that rule.

BIPRU 4.3.110 G

Where a firm is able to demonstrate that the effect is immaterial in accordance with BIPRU 4.1.25 R (Compliance), it may exclude defaultedexposures that have been cured (as referred to in BIPRU 4.3.67 G (1)) or restructured (as referred to in BIPRU 4.3.63 R (5)) from the data about default and loss experience on which LGDs are calculated provided it can demonstrate that its calculation of capital requirements (including capital requirements resulting from the application of capital floors under the transitional rules and guidance in BIPRU) are not reduced as a result of this approximation.

BIPRU 4.3.111 R

Irrespective of whether calculated on an economic downturn or long-run average basis, each LGD estimate must be at least zero.

BIPRU 4.3.112 G

In order to support an LGD estimate which is very low or zero, a firm should be able to demonstrate that the estimate adequately reflects the expected experience on a default weighted average basis or in a downturn as appropriate, taking into account the costs and discount rate associated with realisations and the operation of BIPRU 4.3.118 R.

BIPRU 4.3.113 R

The methods that a firm uses for discounting cash flows for the purposes of estimating LGDs must take account of the uncertainties associated with the receipt of recoveries with respect to a defaulted exposure. If a firm intends to use a discount rate that does not take full account of the uncertainty in recoveries, it must be able to explain by what other process it has taken into account that uncertainty for the purposes of calculating LGDs.

BIPRU 4.3.114 G

The uncertainty referred to in BIPRU 4.3.113 R can be addressed by adjusting cash flows to certainty-equivalents or by using a discount rate that embodies an appropriate risk premium; or by a combination of the two.

BIPRU 4.3.115 G

A firm may exclude from its calculation of loss indirect costs that it incurs for the purpose of making recoveries with respect to a defaulted exposure if it would also have incurred those costs if there had not been a default.

BIPRU 4.3.116 R

A firm must consider the extent of any dependence between the risk of the obligor with that of the collateral or collateral provider. Cases where there is a significant degree of dependence must be addressed in a conservative manner.

[Note:BCD Annex VII Part 4 point 75]

BIPRU 4.3.117 R

Currency mismatches between the underlying obligation and the collateral must be treated conservatively in the firm's assessment of LGD.

[Note:BCD Annex VII Part 4 point 76]

BIPRU 4.3.118 R

To the extent that LGD estimates take into account the existence of collateral, these estimates must not solely be based on the collateral's estimated market value. LGD estimates must take into account the effect of the potential inability of the firm expeditiously to gain control of its collateral and liquidate it.

[Note:BCD Annex VII Part 4 point 77]

BIPRU 4.3.119 G
  1. (1)

    A firm may comply with BIPRU 4.3.118 R by reducing the amount of the collateral taken into account for the purposes of calculating LGD (applying a haircut to the collateral), basing that reduction on validated realisation experience and using conservatism to reflect the uncertainties.

  2. (2)

    If collateral is used to reduce the LGD, a firm should be able to demonstrate how the risk in BIPRU 4.3.118 R has been accounted for. To the extent that it is adequately accounted for in that way it need not be reflected again as part of the residual risk in relation to collateral under the overall Pillar 2 rule.

BIPRU 4.3.120 R

To the extent that LGD estimates take into account the existence of collateral, a firm must establish internal requirements for collateral management, legal certainty and risk management that are generally consistent with those set out in BIPRU 5 (Credit risk mitigation) as modified by BIPRU 4.10.

[Note:BCD Annex VII Part 4 point 78]

BIPRU 4.3.121 R

To the extent that a firm recognises collateral for determining the exposure value for counterparty credit risk according to the CCR standardised method or the CCR internal model method, any amount expected to be recovered from the collateral must not be taken into account in the LGD estimates.

[Note:BCD Annex VII Part 4 point 79]

BIPRU 4.3.122 R

For the specific case of exposures already in default, a firm must use the sum of its best estimate of expected loss for each exposure given current economic circumstances and exposure status and the possibility of additional unexpected losses during the recovery period.

[Note:BCD Annex VII Part 4 point 80]

BIPRU 4.3.123 R

To the extent that unpaid late fees have been capitalised in a firm's income statement, they must be added to the firm's measure of exposure and loss.

[Note:BCD Annex VII Part 4 point 81]

Risk quantification: Overall requirements for estimation: Requirements specific to own-conversion factor estimates

BIPRU 4.3.124 R

BIPRU 4.3.125 R - BIPRU 4.3.131 R set out requirements specific to own-conversion factor estimates.

BIPRU 4.3.125 R

A firm must estimate conversion factors by facility grade or pool on the basis of the average expected conversion factors by facility grade or pool using all observed defaults within the data sources (default weighted average).

[Note:BCD Annex VII Part 4 point 87]

BIPRU 4.3.126 G
  1. (1)

    A firm using own estimates of conversion factors should take into account all facility types that may result in an exposure when an obligor defaults, including uncommitted facilities.

  2. (2)

    A firm should treat a facility as an exposure from the earliest date at which a customer is able to make drawings under it.

  3. (3)

    To the extent that a firm makes available multiple facilities, it should be able to demonstrate:

    1. (a)

      how it deals with the fact that exposures on one may become exposures under another on which the losses are ultimately incurred; and

    2. (b)

      the impact of its approach on its capital requirements.

BIPRU 4.3.127 R

A firm must use conversion factor estimates that are appropriate for an economic downturn if those are more conservative than the long-run average. To the extent a rating system is expected to deliver realised conversion factors at a constant level by grade or pool over time, a firm must make adjustments to its estimates of risk parameters by grade or pool to limit the capital impact of an economic downturn.

[Note:BCD Annex VII Part 4 point 88]

BIPRU 4.3.128 R

A firm's estimates of conversion factors must reflect the possibility of additional drawings by the obligor up to and after the time a default event is triggered. The conversion factor estimate must incorporate a larger margin of conservatism where a stronger positive correlation can reasonably be expected between the default frequency and the magnitude of conversion factor.

[Note:BCD Annex VII Part 4 point 89]

BIPRU 4.3.129 R

In arriving at estimates of conversion factors a firm must consider its specific policies and strategies adopted in respect of account monitoring and payment processing. A firm must also consider its ability and willingness to prevent further drawings in circumstances short of payment default, such as covenant violations or other technical default events.

[Note:BCD Annex VII Part 4 point 90]

BIPRU 4.3.130 R

A firm must have adequate systems and procedures in place to monitor facility amounts, current outstandings against committed lines and changes in outstandings per obligor and per grade. A firm must be able to monitor outstanding balances on a daily basis.

[Note:BCD Annex VII Part 4 point 91]

BIPRU 4.3.131 R

If a firm uses different estimates of conversion factors for the calculation of risk weighted exposure amounts and internal purposes it must be documented. The firm must be able to demonstrate their reasonableness to the appropriate regulator.

[Note:BCD Annex VII Part 4 point 92]

Risk quantification: Overall requirements for estimation: Comparability

BIPRU 4.3.132 G
  1. (1)

    This paragraph contains guidance about the interpretation of the requirements relating to comparability in BIPRU 4.3.85 R. It is also relevant to the requirement for representative data in BIPRU 4.3.51 R (5), to the references to comparability in the additional guidance in BIPRU 4.3.53 G (7)(b) and to the requirements for similarity in BIPRU 4.3.92 R.

  2. (2)

    In general, comparability should be based on analyses of the population of exposures represented in the data, the lending standards used when the data was generated (where relevant) and other relevant characteristics in relation to the corresponding properties of the firm's own portfolio. Other relevant characteristics could include the distribution of the obligors across industries, the size distribution of the exposures and similarity with respect to the geographic or demographic distribution of the exposures.

BIPRU 4.4 The IRB approach: Exposures to corporates, institutions and sovereigns

Application

BIPRU 4.4.1 R
  1. (1)

    This section applies with respect to the sovereign, institution and corporate IRB exposure class.

  2. (2)

    The sovereign, institution and corporate IRB exposure class includes specialised lending exposures.

  3. (3)

    Both BIPRU 4.4 and BIPRU 4.5 (Specialised lending exposures) apply to specialised lending exposures. A firm may calculate risk weighted exposure amounts for a specialised lending exposure either:

    1. (a)

      (if it is able to do so) in accordance with BIPRU 4.4; or

    2. (b)

      in accordance with BIPRU 4.4 as modified by BIPRU 4.5.

Definition

BIPRU 4.4.2 R

The following exposures must be treated as exposures to central governments and central banks:

  1. (1)

    exposures to regional governments, local authorities or public sector entities which are treated as exposures to central governments under the standardised approach; and

  2. (2)

    exposures to multilateral development banks and international organisations which attract a risk weight of 0% under the standardised approach.

[Note:BCD Article 86(2)]

BIPRU 4.4.3 R

The following exposures must be treated as exposures to institutions:

  1. (1)

    exposures to regional governments and local authorities which are not treated as exposures to central governments under the standardised approach;

  2. (2)

    exposures to public sector entities which are treated as exposures to institutions under the standardised approach;

  3. (3)

    exposures to multilateral development banks which do not attract a 0% risk weight under the standardised approach; and

  4. (4)

    without prejudice to BIPRU 13.3.13 R and BIPRU 13.8.7 R (Exposures to a central counterparty) exposures to recognised third country investment firms and exposures to recognised clearing houses and designated investment exchanges.

[Note: BCD Article 86(3) and CAD Article 40]

BIPRU 4.4.4 R

Any credit obligation not assigned to the IRB exposure classes referred to in BIPRU 4.3.2 R (1) (Sovereigns), BIPRU 4.3.2 R (2) (Institutions) and BIPRU 4.3.2 R (4) - BIPRU 4.3.2 R (6) (Retail, equity and securitisations) must be assigned to the corporate exposure class.

[Note:BCD Article 86(7)]

Rating system: Structure of rating system

BIPRU 4.4.5 R

BIPRU 4.4.6 R - BIPRU 4.4.21 R apply in addition to BIPRU 4.3.25 R - BIPRU 4.3.28 R (Rating systems).

BIPRU 4.4.6 R

A rating system must take into account obligor and transaction risk characteristics.

[Note: BCD Annex VII Part 4 point 5]

BIPRU 4.4.7 R

A rating system must have an obligor rating scale which reflects exclusively quantification of the risk of obligor default. The obligor rating scale must have a minimum of seven grades for non-defaulted obligors and one for defaulted obligors.

[Note:BCD Annex VII Part 4 point 6]

BIPRU 4.4.8 R

An obligor grade means for the purpose of BIPRU 4 as it applies to the sovereign, institution and corporate IRB exposure class a risk category within a rating system's obligor rating scale, to which obligors are assigned on the basis of a specified and distinct set of rating criteria, from which estimates of PD are derived. A firm must document both the relationship between obligor grades in terms of the level of default risk each grade implies and the criteria used to distinguish that level of default risk.

[Note:BCD Annex VII Part 4 point 7]

BIPRU 4.4.9 R

A firm with portfolios concentrated in a particular market segment and range of default risk must have enough obligor grades within that range to avoid undue concentrations of obligors in a particular grade. Significant concentrations within a single grade must be supported by convincing empirical evidence that the obligor grade covers a reasonably narrow PD band and that the default risk posed by all obligors in the grade falls within that band.

[Note:BCD Annex VII Part 4 point 8]

Rating system: Assignment to grades or pools

BIPRU 4.4.10 G

Material on assignment to grades or pools can be found in BIPRU 4.3.43 R - BIPRU 4.3.48 R.

Rating system: Assignment of exposures

BIPRU 4.4.11 R

Each obligor must be assigned to an obligor grade as part of the credit approval process.

[Note:BCD Annex VII Part 4 point 19]

BIPRU 4.4.12 R

Each separate legal entity to which a firm is exposed must be separately rated. A firm must be able to demonstrate to the appropriate regulator that it has acceptable policies regarding the treatment of individual obligor clients and groups of connected clients.

[Note:BCD Annex VII Part 4 point 22]

BIPRU 4.4.13 R

Separate exposures to the same obligor must be assigned to the same obligor grade, irrespective of any differences in the nature of each specific transaction. Exceptions, where separate exposures are allowed to result in multiple grades for the same obligor are:

  1. (1)

    country transfer risk, this being dependent on whether the exposures are denominated in local or foreign currency;

  2. (2)

    where the treatment of associated guarantees to an exposure may be reflected in an adjusted assignment to an obligor grade; and

  3. (3)

    where consumer protection, bank secrecy or other legislation prohibit the exchange of client data.

[Note:BCD Annex VII Part 4 point 23]

Rating system: Overrides

BIPRU 4.4.14 G

Material on overrides can be found in BIPRU 4.3.50 R.

Rating system: Integrity of assignment process

BIPRU 4.4.15 R

Assignments and periodic reviews of assignments must be completed or approved by an independent party that does not directly benefit from decisions to extend the credit.

[Note:BCD Annex VII Part 4 point 26]

BIPRU 4.4.16 R

A firm must update assignments at least annually. High risk obligors and problem exposures must be subject to more frequent review. A firm must undertake a new assignment if material information on the obligor or exposure becomes available.

[Note:BCD Annex VII Part 4 point 27]

BIPRU 4.4.17 G

Although it will not usually be the case that facility ratings and conversion factors will have to be updated more frequently than annually, LGDs and exposure values are subject to more frequent recalculation due to their connection to drawn balances, which can vary on a daily basis.

BIPRU 4.4.18 R

A firm must have an effective process to obtain and update relevant information on obligor characteristics that affect PDs, and on transaction characteristics that affect LGDs and conversion factors.

[Note:BCD Annex VII Part 4 point 28]

Rating system: Use of models

BIPRU 4.4.19 G

Material on the use of models can be found in BIPRU 4.3.51 R - BIPRU 4.3.53 G.

Rating system: Documentation of rating systems

BIPRU 4.4.20 G

Material on the documentation of rating systems can be found in BIPRU 4.3.19 R - BIPRU 4.3.24 R.

Rating system: Data maintenance

BIPRU 4.4.21 R

In addition to complying with the material in BIPRU 4.3.54 R (Data maintenance) a firm must collect and store:

  1. (1)

    complete rating histories on obligors and recognised guarantors;

  2. (2)

    the dates the ratings were assigned;

  3. (3)

    the key data and methodology used to derive the rating;

  4. (4)

    the person responsible for the rating assignment;

  5. (5)

    the identity of obligors and exposures that defaulted;

  6. (6)

    the date and circumstances of such defaults;

  7. (7)

    data on the PDs and realised default rates associated with rating grades and ratings migration; and

  8. (8)

    (in the case of a firm not using the advanced IRB approach in the calculation of LGDs and/or conversion factors) data on comparisons of realised LGDs to the values as set out in BIPRU 4.4.34 R and BIPRU 4.8.25 R and realised conversion factors to the values as set out in BIPRU 4.4.37 R, BIPRU 4.4.45 R and BIPRU 4.6.44 R.

[Note:BCD Annex VII Part 4 point 37]

Risk quantification: Definition of default

BIPRU 4.4.22 R
  1. (1)

    This rule, in accordance with BIPRU 4.3.57 R (4) (Definition of default), sets the exact number of days past due that a firm should abide by in the case of exposures to PSEs.

  2. (2)

    For counterparts that are PSEs situated within the United Kingdom the number of days past due is 180.

  3. (3)

    For counterparts that are PSEs situated in another EEA State the number of days past due is the lower of:

    1. (a)

      180; and

    2. (b)

      the number of days past due fixed under the CRD implementation measure with respect to point 48 of Part 4 of Annex VII of the Banking Consolidation Directive for that EEA State for such exposures.

  4. (4)

    For counterparts that are PSEs in a state outside the EEA the number of days past due is the lower of:

    1. (a)

      180; and

    2. (b)

      (if a number of days past due for such exposures has been fixed under any law of that state applicable to undertakings in the banking sector or the investment services sector that implements the IRB approach) that number.

[Note:BCD Annex VII Part 4 point 44 (part) and point 48 (part)]

Risk quantification: Overall requirements for estimation: Requirements specific to PD estimation

BIPRU 4.4.23 R
BIPRU 4.4.24 R

A firm must estimate PDs by obligor grade from long run averages of one-year default rates.

[Note:BCD Annex VII Part 4 point 59]

BIPRU 4.4.25 R

A firm must use PD estimation techniques only with supporting analysis. A firm must recognise the importance of judgmental considerations in combining results of techniques and in making adjustments for limitations of techniques and information.

[Note:BCD Annex VII Part 4 point 62]

BIPRU 4.4.26 G

Where rating agency experience or the output of a statistical default model are the primary component of PD estimation, a firm should consider whether it needs to make adjustments for other relevant information, such as internal experience, conservatism and cyclical effects. In making these adjustments, a firm should consider the extent to which it needs to take account of the potential for both under-recording of actual defaults experienced and divergence of actual experience from the true underlying average PD.

BIPRU 4.4.27 R

To the extent that a firm uses data on internal default experience for the estimation of PDs it must be able to demonstrate in its analysis that the estimates are reflective of underwriting standards and of any differences in the rating system that generated the data and the current rating system. Where underwriting standards or rating systems have changed, a firm must add a greater margin of conservatism in its estimate of PD.

[Note:BCD Annex VII Part 4 point 63]

BIPRU 4.4.28 R

To the extent that a firm associates or maps its internal grades to the scale used by an ECAI or similar organisations and then attributes the default rate observed for the external organisation's grades to the firm's grades, mappings must be based on a comparison of internal rating criteria to the criteria used by the external organisation and on a comparison of the internal and external ratings of any common obligors. Biases or inconsistencies in the mapping approach or underlying data must be avoided. The external organisation's criteria underlying the data used for quantification must be oriented to default risk only and not reflect transaction characteristics. The firm's analysis must include a comparison of the default definitions used, subject to the requirements in BIPRU 4.3.56 R to BIPRU 4.3.71 R and BIPRU 4.4.22 R (Definition of default). The firm must document the basis for the mapping.

[Note:BCD Annex VII Part 4 point 64]

BIPRU 4.4.29 G

It is unlikely that a firm will be able to convince the appropriate regulator that it had considered all relevant and available information, as required by BIPRU 4.3.74 R, if it used only data from one ECAI or similar organisation, where other relevant information is available.

BIPRU 4.4.30 R

To the extent that a firm uses statistical default prediction models it may estimate PDs as the simple average of default-probability estimates for individual obligors in a given grade. The firm's use of default probability models for this purpose must meet the standards specified in BIPRU 4.3.51 R.

[Note:BCD Annex VII Part 4 point 65]

BIPRU 4.4.31 R

Irrespective of whether a firm is using external, internal, or pooled data sources, or a combination of the three, for its PD estimation, the length of the underlying historical observation period used must be at least five years for at least one source. If the available observation period spans a longer period for any source, and this data is relevant, this longer period must be used. A firm not permitted to use own estimates of LGDs or conversion factors may have, when it implements the IRB approach, relevant data covering a period of two years. The period to be covered must increase by one year each year until relevant data cover a period of five years.

[Note:BCD Annex VII Part 4 point 66 (part)]

IRB foundation approach: General

BIPRU 4.4.32 R

BIPRU 4.4.33 R - BIPRU 4.4.39 R set out requirements specific to the foundation IRB approach.

BIPRU 4.4.33 R

Under the foundation IRB approach a firm must apply the LGD values set out in BIPRU 4.4.34 R and BIPRU 4.8.25 R and the conversion factors set out in BIPRU 4.4.37 R.

[Note:BCD Article 87(8)]

IRB foundation approach: LGDs

BIPRU 4.4.34 R

A firm must use the following LGD values:

  1. (1)

    senior exposures without eligible collateral, 45%;

  2. (2)

    subordinated exposures without eligible collateral, 75%;

  3. (3)

    a firm may recognise funded and unfunded credit protection in the LGD in accordance with BIPRU 5 (Credit risk mitigation), as modified by BIPRU 4.10;

  4. (4)

    covered bonds may be assigned an LGD value of 11.257%; and

    7
  5. (5)

    for certain senior corporate exposure purchased receivables, for certain subordinated corporate exposure purchased receivables and for dilution risk of corporate purchased receivables the provisions of BIPRU 4.8.25 R (LGDs for corporate receivables) apply.

[Note:BCD Annex VII Part 2 point 8 (part)]

BIPRU 4.4.35 R

[deleted]7

7
  1. (1)

    [deleted]7

    7
  2. (2)

    [deleted]7

    7
  3. (3)

    [deleted]7

    7
  4. (4)

    [deleted]7

    7
7

Foundation IRB approach: Exposure value and conversion factors

BIPRU 4.4.36 R
BIPRU 4.4.37 R
  1. (1)

    The exposure value for the items set out in this rule must be calculated as the committed but undrawn amount multiplied by the applicable conversion factor set out in this rule.

  2. (2)

    For credit lines which are uncommitted, that are unconditionally cancellable at any time by the firm without prior notice, or that effectively provide for automatic cancellation due to deterioration in a borrower's credit worthiness, a conversion factor of 0 % applies. To apply a conversion factor of 0% a firm must actively monitor the financial condition of the obligor, and its internal control systems must enable it immediately to detect a deterioration in the credit quality of the obligor.

  3. (3)

    For short-term letters of credit arising from the movement of goods, a conversion factor of 20% applies for both the issuing and confirming firms.

  4. (4)

    For other credit lines, note issuance facilities (NIFs), and revolving underwriting facilities (RUFs), a conversion factor of 75% applies.

  5. (5)

    For undrawn purchase commitments for revolving purchased receivables falling under BIPRU 4.8.29 R, the conversion factor set out in that rule applies.

[Note:BCD Annex VII Part 3 point 9 (part)]

BIPRU 4.4.38 R

Where a commitment refers to the extension of another commitment, the lower of the two conversion factors associated with the individual commitment must be used.

[Note:BCD Annex VII Part 3 point 10]

BIPRU 4.4.39 R

For all off-balance sheet items other than mentioned in BIPRU 4.4.37 R, BIPRU 4.4.45 R, BIPRU 4.4.71 R - BIPRU 4.4.78 R, BIPRU 4.6.44 R, BIPRU 4.8.28 R and BIPRU 4.8.29 R, the exposure value must be the following percentage of its value:

  1. (1)

    100% if it is a full risk item;

  2. (2)

    50% if it is a medium risk item;

  3. (3)

    20% if it is a medium/low risk item; and

  4. (4)

    0% if it is a low risk item.

For the purposes of this rule the off-balance sheet items must be assigned to risk categories as indicated in BIPRU 3.7 (Classification of off-balance sheet items).

[Note:BCD Annex VII Part 3 point 11]

Advanced IRB approach: General

BIPRU 4.4.40 R

1 BIPRU 4.4.41 R - BIPRU 4.4.55 R set out requirements specific to the advanced IRB approach.

BIPRU 4.4.41 R

1Under the advanced IRB approach a firm must use its own estimates of LGDs and conversion factors in accordance with BIPRU 4.

[Note:BCD Article 87(9)]

Advanced IRB approach: LGDs and PDs

BIPRU 4.4.42 R

1A firm using own LGD estimates under the advanced IRB approach may recognise unfunded credit protection by adjusting PDs subject to BIPRU 4.4.43 R.

[Note:BCD Annex VII Part 2 point 6]

BIPRU 4.4.43 R

1Notwithstanding BIPRU 4.4.34 R and BIPRU 4.8.25 R, if a firm'sIRB permission permits it to use own LGD estimates under the advanced IRB approach for exposures to which BIPRU 4 applies and permits it to use the approach in this rule, unfunded credit protection may be recognised by adjusting PD and/or LGD estimates subject to the minimum IRB standards. A firm must not assign guaranteed exposures an adjusted PD or LGD such that the adjusted risk weight would be lower than that of a comparable, direct exposure to the guarantor.

[Note:BCD Annex VII Part 2 point 10]

BIPRU 4.4.44 G

1A firm using the advanced IRB approach may only recognise unfunded credit protection in accordance with BIPRU 4.4.43 R. The other methods for recognising unfunded credit risk mitigation under the standardised approach and foundation IRB approach are not available to a firm on the advanced IRB approach.

Advanced IRB approach: Conversion factors

BIPRU 4.4.45 R

1If a firm uses its own estimates of conversion factors under the advanced IRB approach it must calculate the exposure value of off-balance sheet exposures calculated with the use of conversion factors by using its own estimates of conversion factors across different product types as mentioned in BIPRU 4.4.37 R and BIPRU 4.4.39 R (2) to BIPRU 4.4.39 R (4).

[Note:BCD Annex VII Part 3 point 9 (part)]

BIPRU 4.4.46 G

1Under BIPRU 4.4.45 R, a firm may calculate exposure values by calculating the amount expected to be claimed, instead of the maximum possible amount of the potential claim. The figure for the amount expected to be claimed should not be less than the current outstandings from time to time.

Advanced IRB approach: Structure of the rating system

BIPRU 4.4.47 R
BIPRU 4.4.48 R

1If a firm'sIRB permission provides for it to use the advanced IRB approach for the calculation of LGDs, its rating system must incorporate a distinct facility rating scale which exclusively reflects LGD related transaction characteristics.

[Note:BCD Annex VII Part 4 point 9]

BIPRU 4.4.49 R

1A facility grade means for the purpose of the advanced IRB approach a risk category within a rating system's facility scale to which exposures are assigned on the basis of a specified and distinct set of rating criteria from which own estimates of LGDs are derived. The grade definition must include both a description of how exposures are assigned to the grade and of the criteria used to distinguish the level of risk across grades.

[Note:BCD Annex VII Part 4 point 10]

BIPRU 4.4.50 R

1Significant concentrations within a single facility grade must be supported by convincing empirical evidence that the facility grade covers a reasonably narrow LGD band, respectively, and that the risk posed by all exposures in the grade falls within that band.

[Note:BCD Annex VII Part 4 point 11]

Advanced IRB approach: Assignment of exposures

BIPRU 4.4.51 R

1For a firm permitted to use own estimates of LGDs or conversion factors under the advanced IRB approach, each exposure must be assigned to a facility grade as part of the credit approval process. This is in addition to the requirements in BIPRU 4.4.11 R - BIPRU 4.4.13 R.

[Note:BCD Annex VII Part 4 point 20]

BIPRU 4.4.52 G

1 BIPRU 4.4.50 R and BIPRU 4.4.51 R should be read in the light of BIPRU 4.3.28 R.

Advanced IRB approach: Data maintenance

BIPRU 4.4.53 R

1As well as complying with BIPRU 4.3.54 R and BIPRU 4.4.21 R (Data maintenance), a firm using own estimates of LGDs and/or conversion factors under the advanced IRB approach must collect and store:

  1. (1)

    complete histories of data on the facility ratings and LGD and conversion factor estimates associated with each rating scale3;

  2. (2)

    the dates the ratings were assigned and the estimates were done;

  3. (3)

    the key data and methodology used to derive the facility ratings and LGD and conversion factor estimates;

  4. (4)

    the person who assigned the facility rating and the person who provided LGD and conversion factor estimates;

  5. (5)

    data on the estimated and realised LGDs and conversion factors associated with each defaultedexposure;

  6. (6)

    data on the LGD of the exposure before and after evaluation of the effects of a guarantee or credit derivative, for a firm that reflects the credit risk mitigating effects of guarantees or credit derivatives through LGD; and

  7. (7)

    data on the components of loss for each defaultedexposure.

[Note:BCD Annex VII Part 4 Point 38]

Advanced IRB approach: Requirements specific to own-LGD estimates

BIPRU 4.4.54 R

1In addition to the requirements in BIPRU 4.3.74 R - BIPRU 4.3.94 R (General requirements about risk quantification) and BIPRU 4.3.98 R - BIPRU 4.3.123 R (Requirements for risk quantification specific to own-LGD estimates), estimates of LGD must be based on data over a minimum of five years, increasing by one year each year after implementation until a minimum of seven years is reached, for at least one data source. If the available observation period spans a longer period for any source, and the data is relevant, this longer period must be used.

[Note:BCD Annex VII Part 4 point 82]

Advanced IRB approach: Requirements specific to own-conversion factor estimates

BIPRU 4.4.55 R

1In addition to the requirements in BIPRU 4.3.124 R - BIPRU 4.3.131 R (Requirements specific to own-conversion factor estimates), estimates of conversion factors must be based on data over a minimum of five years, increasing by one year each year after implementation until a minimum of seven years is reached, for at least one data source. If the available observation period spans a longer period for any source, and the data is relevant, this longer period must be used.

[Note:BCD Annex VII Part 4 point 93]

Calculations: General

BIPRU 4.4.56 R

The remainder of this section applies to both the foundation IRB approach and the advanced IRB approach.

Calculations: Risk-weighted exposure amounts

BIPRU 4.4.57 R

Subject to BIPRU 4.4.59 R to BIPRU 4.4.60 R, BIPRU 4.5.6 R, BIPRU 4.5.8 R - BIPRU 4.5.10 R (Risk weights for specialised lending), BIPRU 4.8.16 R, BIPRU 4.8.17 R (Risk weights for corporate exposure purchased receivables) and BIPRU 4.9.3 R (Securitisation: provision of credit protection), risk weighted exposure amounts must be calculated according to the formulae in the table in BIPRU 4.4.58 R and the adjustment formula in BIPRU 4.4.79 R (Double default).

[Note:BCD Annex VII Part 1 point 3]

BIPRU 4.4.58 R

Table: Formulae for the calculation of risk weighted exposure amounts

This table belongs to BIPRU 4.4.57 R

Correlation (R)

0.12 × (1 - EXP(-50*PD))/(1-EXP(-50)) + 0.24*

[1-(1-EXP(-50*PD))/(1-EXP(-50))]

Maturity factor (b)

(0.11852-0.05478*1n(PD))2

(LGD*N[(1-R)-0.5*G(PD)+(R/(1-R))0.5 *G(0.999)]-PD*LGD)*

(1-1.5*b)-1*(1+(M-2.5)*b)*12.5*1.06

N(x)

denotes the cumulative distribution function for a standard normal random variable (i.e. the probability that a normal random variable with mean zero and variance of one is less than or equal to x). G(z) denotes the inverse cumulative distribution function for a standard normal random variable (i.e. the value x such that N(x) = z).

PD = 0

For PD = 0, RW shall be: 0

PD = 1

For PD = 1:

(i)

for defaultedexposures where a firm applies the LGD values set out in BIPRU 4.4.32R and BIPRU 4.8.25R RW shall be: 0;

(ii)

for defaultedexposures where a firm uses its own estimates of LGDs, RW shall be: Max {0, 12.5 *(LGD-ELBE)};

where ELBEmust be the firm's best estimate of expected loss for the defaultedexposure according to BIPRU 4.3.122 R.

[Note:BCD Annex VII Part 1 point 3]

BIPRU 4.4.59 R

For exposures to companies where the total annual sales for the consolidated group of which the firm is a part is less than EUR 50 million a firm may use the following correlation formula for the calculation of risk weights for corporate exposures. In this formula S is expressed as total annual sales in millions of Euros with EUR 5 million < = S < = EUR 50 million. Reported sales of less than EUR 5 million must be treated as if they were equivalent to EUR 5 million. In accordance with BIPRU 4.8.21 R, for purchased receivables the total annual sales are the weighted average by individual exposures of the pool. The formula for the calculation of correlation (R) is:

0.12×(1-EXP(-50*PD))/(1-EXP(-50))+ 0.24*

[1-(1-4EXP(-50*PD))/(1-EXP(-50))]

-0.04*(1-(S-5)/45)

[Note:BCD Annex VII Part 1 point 5 (part)]

BIPRU 4.4.60 R

A firm must for the purpose of BIPRU 4.4.59 R substitute total assets of the consolidated group for total annual sales when total annual sales are not a meaningful indicator of firm size and total assets are a more meaningful indicator than total annual sales.

[Note:BCD Annex VII Part 1 point 5 (part)]

Calculations: Expected loss amounts

BIPRU 4.4.61 R

Expected loss amounts must be calculated according to the formulae in the table in BIPRU 4.4.62 R.

[Note:BCD Annex VII Part 1 point 30 (part)]

BIPRU 4.4.62 R

3Table: Formulae for the calculation of expected loss amounts

This table belongs to BIPRU 4.4.61 R

Expected loss (EL)

equals PD×LGD

Expected loss amount

equals EL×exposure value

For defaultedexposures (PD = 1) where a firm uses its own estimates of LGDs, EL must be ELBE, the firm's best estimate of expected loss for the defaultedexposure according to BIPRU 4.3.122 R.

For exposures subject to the treatment set out in BIPRU 4.4.79 R (Double default) EL must be 0.

[Note:BCD Annex VII Part 1 point 30 (part)]

Calculations: PD

BIPRU 4.4.63 R

A firm must provide its own estimates of PDs in accordance with its IRB permission and the minimum IRB standards.

[Note: BCD Article 87(6) (part)]

BIPRU 4.4.64 R

The PD of a corporate exposure or an exposure in the IRB exposure class referred to in BIPRU 4.3.2 R (2) (Institutions) must be at least 0.03%.

[Note:BCD Annex VII Part 2 point 2]

BIPRU 4.4.65 R

The PD of obligors in default must be 100%.

[Note:BCD Annex VII Part 2 point 4]

BIPRU 4.4.66 R

Subject to BIPRU 4.4.42 R (Advanced IRB approach: LGDs and PDs) a firm may recognise unfunded credit protection in the PD in accordance with the provisions of BIPRU 5 (Credit risk mitigation), as modified by BIPRU 4.10. For dilution risk, however, a firm may also recognise unfunded credit protection providers which are specified in its IRB permission in addition to those indicated in the CRM eligibility conditions.

[Note:BCD Annex VII Part 2 point 5]

Calculations: Maturity

BIPRU 4.4.67 R
  1. (1)

    A firm must calculate maturity (M) for each of the exposures referred to in this rule in accordance with this rule and subject to BIPRU 4.4.68 R to BIPRU 4.4.70 R. In all cases, M must be no greater than 5 years.

  2. (2)

    For an instrument subject to a cash flow schedule M must be calculated according to the following formula:

    BIPRU_Chapter_4_001

    where CFt denotes the cash flows (principal, interest payments and fees) contractually payable by the obligor in period t.

  3. (3)

    For derivatives subject to a master netting agreement M must be the weighted average remaining maturity of the exposure, where M must be at least 1 year. The notional amount of each exposure must be used for weighting the maturity.

  4. (4)

    For exposures arising from fully or nearly-fully collateralised financial derivative instruments transactions and fully or nearly-fully collateralised margin lending transactions which are subject to a master netting agreement M must be the weighted average remaining maturity of the transactions where M must be at least 10 days. For repurchase transactions or securities or commodities lending or borrowing transactions which are subject to a master netting agreement, M must be the weighted average remaining maturity of transactions, where M must be at least 5 days.6 The notional amount of each transaction must be used for weighting the maturity.

  5. (5)

    Where a firm uses the CCR internal model method to calculate the exposure values, M must be calculated for exposures to which a firm applies this method and for which the maturity of the longest-dated contract contained in the netting set is greater than one year according to the following formula:

    BIPRU_Chapter_4_002

    where:

    dfk = the risk-free discount factor for future time period tk and the remaining symbols are defined in BIPRU 13.6.

  6. (6)

    Notwithstanding (7), a firm that uses a CCR internal model method model to calculate a one-sided credit valuation adjustment2 (CVA) may use the effective credit duration estimated by the model as M if permitted to do so by its CCR internal model method permission.

  7. (7)

    Subject to BIPRU 4.4.68 R, for netting sets in which all contracts have an original maturity of less than one year the formula in (2) must be applied.

  8. (8)

    If a firm is permitted under its IRB permission to use own PD estimates for corporate exposure purchased receivables, for drawn amounts M must equal the purchased receivables exposure weighted average maturity, where M must be at least 90 days. This same value of M must also be used for undrawn amounts under a committed purchase facility provided the facility contains effective covenants, early amortisation triggers, or other features that protect the purchasing firm against a significant deterioration in the quality of the future receivables it is required to purchase over the facility's term. Absent such effective protections, M for undrawn amounts must be calculated as the sum of the longest-dated potential receivable under the purchase agreement and the remaining maturity of the purchase facility, where M must be at least 90 days.

  9. (9)

    For any other instrument than mentioned in this rule or when a firm is not in a position to calculate M as set out in (2), M must be the maximum remaining time (in years) that the obligor is permitted to take fully to discharge its contractual obligations, where M must be at least 1 year.

  10. (10)

    5Notwithstanding (2) and (9), M must be at least one-day for:

    1. (a)

      import letters of credit (including standby letters of credit issued for similar purposes) and acceptances under them;

    2. (b)

      export letters of credit confirmation and negotiation;

    3. (c)

      pre-shipment and post-shipment acceptances and financing;

    4. (d)

      export and import loans collateralised by underlying goods, up to a maximum maturity of 180 days; and

    5. (e)

      performance guarantees, bid bonds and other guarantees (including standby letters of credit issued for similar purposes) relating to the export and import of goods and services;

      provided these exposures are not part of the firm's ongoing financing of the obligor.

[Note:BCD Annex VII Part 2 point 13 (part)]

BIPRU 4.4.68 R

Notwithstanding BIPRU 4.4.67 R (2) - (4)6 and (8)-(9), M must be at least one-day for:

6
  1. (1)

    fully or nearly-fully collateralised financial derivative instruments;

  2. (2)

    fully or nearly-fully collateralised margin lending transactions; and

  3. (3)

    repurchase transactions, securities or commodities lending or borrowing transactions,

provided the documentation requires daily remargining and daily revaluation and includes provisions that allow for the prompt liquidation or setoff of collateral in the event of default or failure to re-margin.

[Note:BCD Annex VII Part 2 point 14 (part)]

BIPRU 4.4.69 G

The last paragraph of paragraph 14 of Part 2 of Annex VII of the Banking Consolidation Directive says: "In addition, for other short-term exposures specified by the competent authorities which are not part of the credit institution's ongoing financing of the obligor, M shall be at least one-day. A careful review of the particular circumstances shall be made in each case." BIPRU 4.4.67R (10) is currently the only instance where the appropriate regulator has specified any such short-term exposures5.

[Note:BCD Annex VII Part 2 point 14 (part)]

5
BIPRU 4.4.70 R

Maturity mismatches must be treated as specified in BIPRU 4.10 and BIPRU 5 (Credit risk mitigation).

[Note:BCD Annex VII Part 2 point 16]

Calculations: Exposure value

BIPRU 4.4.71 R

Unless provided otherwise in BIPRU 4 the exposure value of on-balance sheet exposures must be measured gross of value adjustments. This also applies to assets purchased at a price different than the amount owed. For purchased assets, the difference between the amount owed and the net value recorded on the balance-sheet of the firm is denoted discount if the amount owed is larger, and premium if it is smaller.

[Note:BCD Annex VII Part 3 point 1]

BIPRU 4.4.72 R

A firm must not treat the exposure value of a facility as being less than current drawings under it. Interest accrued to date on an exposure under a facility must be included in current drawings or an allowance for it must be built into the conversion factor.

BIPRU 4.4.73 R

Where a firm uses master netting agreements in relation to repurchase transactions or securities or commodities lending or borrowing transactions the exposure value must be calculated in accordance with BIPRU 5 (Credit risk mitigation), as modified by BIPRU 4.10, and BIPRU 13.8.

[Note:BCD Annex VII Part 3 point 2]

BIPRU 4.4.74 R

For on-balance sheet netting of loans and deposits a firm must apply for the calculation of the exposure value the methods set out in BIPRU 5 (Credit risk mitigation), as modified by BIPRU 4.10.

[Note:BCD Annex VII Part 3 point 3]

BIPRU 4.4.75 R

The exposure value for leases must be the discounted minimum lease payments. Minimum lease payments are the payments over the lease term that the lessee is or can be required to make and any bargain option (i.e. option the exercise of which is reasonably certain). Any guaranteed residual value fulfilling the set of conditions in BIPRU 5.7.1 R (Eligibility), as modified by BIPRU 4.10.38 R and BIPRU 4.10.39 R (Unfunded credit protection: Eligibility of providers) regarding the eligibility of protection providers as well as the minimum requirements for recognising other types of guarantees provided in BIPRU 5.7.6 R (Minimum requirements: General) to BIPRU 5.7.12 R (Additional requirements for guarantees) should also be included in the minimum lease payments.

[Note:BCD Annex VII Part 3 point 4]

BIPRU 4.4.76 R

Where an exposure takes the form of securities or commodities sold, posted or lent under repurchase transactions or securities or commodities lending or borrowing transactions, long settlement transactions and margin lending transactions, the exposure value must be the value of the securities or commodities determined in accordance with GENPRU 1.3 (Valuation). Where the financial collateral comprehensive method is used, the exposure value must be increased by the volatility adjustment appropriate to such securities or commodities as set out in BIPRU 4.10 and BIPRU 5 (Credit risk mitigation). The exposure value of repurchase transactions, securities or commodities lending or borrowing transactions, long settlements transactions and margin lending transactions must be determined in accordance with BIPRU 13.

[Note:BCD Annex VII Part 3 point 7]

BIPRU 4.4.77 R

Notwithstanding BIPRU 4.4.76 R, the exposure value of credit risk exposures outstanding, as determined by the firm, with a central counterparty must be determined in accordance with BIPRU 13.3.3 R and BIPRU 13.8.8 R (Exposure to central counterparty), provided that the central counterparty'sCCRexposures with all participants in its arrangements are fully collateralised on a daily basis.

[Note:BCD Annex VII Part 3 point 8]

BIPRU 4.4.78 R

In the case of any financial derivative instrument, the exposure value must be determined by the methods set out in BIPRU 13.

[Note:BCD Annex VII Part 3 point 5]

Double default

BIPRU 4.4.79 R

The risk weighted exposure amount for each exposure which meets the requirements set out in BIPRU 5.7.2 R and BIPRU 4.4.83 R (Double default) may be adjusted according to the following formula:

  1. (1)

    Risk weighted exposure amount = RW *exposure value * (0.15 + 160*PDpp)]

  2. (2)

    PDpp = PD of the protection provider

  3. (3)

    RW must be calculated using the relevant risk weight formula set out in BIPRU 4.4.57 R for the exposure, the PD of the obligor and the LGD of a comparable direct exposure to the protection provider. The maturity factor (b) must be calculated using the lower of the PD of the protection provider and the PD of the obligor.

[Note:BCD Annex VII Part 1 point 4]

BIPRU 4.4.80 R

Notwithstanding BIPRU 4.4.34 R and BIPRU 4.4.43 R, for the purposes of BIPRU 4.4.79 R, the LGD of a comparable direct exposure to the protection provider shall either be the LGD associated with an unhedged facility to the guarantor or the unhedged facility of the obligor, depending upon whether in the event both the guarantor and the obligor default during the life of the hedged transaction available evidence and the structure of the guarantee indicate that the amount recovered would depend on the financial condition of the guarantor or obligor, respectively

[Note:BCD Annex VII Part 2 point 11]

BIPRU 4.4.81 R

For the purposes of BIPRU 4.4.79 R, M must be the effective maturity of the credit protection but at least 1 year.

[Note:BCD Annex VII Part 2 point 13 (part)]

BIPRU 4.4.82 R

BIPRU 4.4.83 R applies to the eligibility of protection providers under the IRB approach which qualify for the treatment set out in BIPRU 4.4.79 R.

BIPRU 4.4.83 R

An institution, an insurance undertaking (including an insurance undertaking that carries out reinsurance) or an export credit agency which fulfils the following conditions may be recognised as an eligible provider of unfunded credit protection which qualifies for the treatment set out in BIPRU 4.4.79 R:

  1. (1)

    the protection provider has sufficient expertise in providing unfunded credit protection;

  2. (2)

    the protection provider is regulated in a manner equivalent to the rules laid down in the Banking Consolidation Directive or had, at the time the credit protection was provided, a credit assessment by an eligible ECAI3 which is associated with credit quality step 3 or above under the rules for the risk weighting of exposures to corporates under the standardised approach;

  3. (3)

    the protection provider had, at the time the credit protection was provided, or for any period of time thereafter, an internal rating with a PD equivalent to or lower than that associated with credit quality step 2 or above under the rules for the risk weighting of exposures to corporates under the standardised approach;

  4. (4)

    the protection provider has an internal rating with a PD equivalent to or lower than that associated with credit quality step 3 or above under the rules for the risk weighting of exposures to corporates under the standardised approach;

For the purpose of this rule, credit protection provided by an export credit agency must not benefit from any explicit central government counter-guarantee.

[Note:BCD Annex VIII Part 1 point 29]

BIPRU 4.4.84 R

BIPRU 4.4.85 R applies to the requirements to qualify for the treatment set out in BIPRU 4.4.79 R.

BIPRU 4.4.85 R

To be eligible for the treatment set out in BIPRU 4.4.79 R, credit protection deriving from a guarantee or credit derivative must meet the following conditions:

  1. (1)

    the underlying obligation must be to:

    1. (a)

      a corporate exposure, excluding an exposure to an insurance undertaking (including an insurance undertaking that carries out reinsurance); or

    2. (b)

      an exposure to a regional government, local authority or public sector entity which is not treated as an exposure to a central government or a central bank2 according to BIPRU 4.4.2 R; or

    3. (c)

      an exposure to retail SME, classified as a retail exposure according to BIPRU 4.6.2 R;

  2. (2)

    the underlying obligors must not be members of the same group as the protection provider;

  3. (3)

    the exposure must be hedged by one of the following instruments:

    1. (a)

      single name unfunded credit derivatives or single name guarantees;

    2. (b)

      first to default basket products, with these the treatment must be applied to the asset within the basket with the lowest risk weighted exposure amount;

    3. (c)

      nth to default basket products, with these the protection obtained is only eligible for consideration under this framework if eligible (n-1)thdefault protection has also been obtained or where (n-1) of the assets within the basket has/have already defaulted and where this is the case the treatment must be applied to the asset within the basket with the lowest risk weighted exposure amount;

  4. (4)

    the credit protection must meet the requirements set out in BIPRU 5.7.6 R - BIPRU 5.7.8 R (Minimum requirements: Operational requirements), BIPRU 5.7.11 R (Additional requirements for guarantees) and BIPRU 5.7.13 R - BIPRU 5.7.14 R (Additional requirements for credit derivatives);

  5. (5)

    the risk weight that is associated with the exposure prior to the application of the treatment in BIPRU 4.4.79 R does not already factor in any aspect of the credit protection;

  6. (6)

    a firm must have the right and expectation to receive payment from the protection provider without having to take legal action in order to pursue the counterparty for payment;

  7. (7)

    the purchased credit protection must absorb all credit losses incurred on the hedged portion of an exposure that arise due to the occurrence of credit events outlined in the contract;

  8. (8)

    if the payout structure provides for physical settlement, then there must be legal certainty with respect to the deliverability of a loan, bond or contingent liability and if a firm intends to deliver an obligation other than the underlying exposure, it must ensure that the deliverable obligation is sufficiently liquid so that the firm would have the ability to purchase it for delivery in accordance with the contract;

  9. (9)

    the terms and conditions of credit protection arrangements must be legally confirmed in writing by both the protection provider and the firm;

  10. (10)

    a firm must have a process in place to detect excessive correlation between the creditworthiness of a protection provider and the obligor of the underlying exposure due to their performance being dependent on common factors beyond the systematic risk factor;

  11. (11)

    in the case of protection against dilution risk, the seller of purchased receivables must not be a member of the same group as the protection provider; and

  12. (12)

    with reference to (6), to the extent possible, a firm must take steps to satisfy itself that the protection provider is willing to pay promptly should a credit event occur.

[Note:BCD Annex VIII Part 2 point 22]

BIPRU 4.5 The IRB approach: Specialised lending exposures

Application

BIPRU 4.5.1 R

BIPRU 4.5 applies with respect to the exposures referred to in BIPRU 4.5.3 R.

BIPRU 4.5.2 R

Except for BIPRU 4.5.1 R and BIPRU 4.5.3 R, BIPRU 4.5 only applies to the extent that a firm applies the method in BIPRU 4.5 (slotting).

Definition of specialised lending

BIPRU 4.5.3 R

Within the corporate exposureIRB exposure class, a firm must separately identify as specialised lending exposures, exposures which possess the following characteristics:

  1. (1)

    the exposure is to an entity which was created specifically to finance and/or operate physical assets;

  2. (2)

    the contractual arrangements give the lender a substantial degree of control over the assets and the income that they generate; and

  3. (3)

    the primary source of repayment of the obligation is the income generated by the assets being financed, rather than the independent capacity of a broader commercial enterprise.

[Note:BCD Article 86(6)]

Treatment of specialised lending

BIPRU 4.5.4 R

If a firm is using or is applying to use the advanced IRB approach for some or all of its exposures in the sovereign, institution and corporate IRB exposure class, then specialised lending exposures treated under BIPRU 4.5.8 R (Slotting) must be treated as being dealt with under the advanced IRB approach for the purposes of the calculations in BIPRU 4.2.30 R and BIPRU 4.2.31 R. If a firm is not using or applying to use the advanced IRB approach for any of its exposures in the sovereign, institution and corporate IRB exposure class, in the cases in which it is necessary to distinguish between the advanced IRB approach and the foundation IRB approach, then specialised lending exposures treated under BIPRU 4.5.8 R must be treated as being dealt with under the foundation IRB approach for the purposes of the calculations in BIPRU 4.2.30 R and BIPRU 4.2.31 R.

Structure of rating system

BIPRU 4.5.5 R

A firm using the methods set out in BIPRU 4.5.8 R (Slotting) for assigning risk weights for specialised lending exposures is exempt from the requirement to have an obligor rating scale which reflects exclusively quantification of the risk of obligor default for these exposures. Notwithstanding BIPRU 4.4.7 R (Seven grades for exposures to sovereigns, institutions and corporates), a firm must have for these exposures four grades for non-defaulted obligors and one grade for defaulted obligors.

[Note:BCD Annex VII Part 4 point 12 and point 21]

Assignment of exposures

BIPRU 4.5.6 R
  1. (1)

    A firm using the methods set out in BIPRU 4.5.8 R (Slotting) for assigning risk weights for specialised lending exposures must assign each of these exposures to a grade in accordance with BIPRU 4 Annex 1 R, taking into account the following factors:

    1. (a)

      financial strength;

    2. (b)

      political and legal environment;

    3. (c)

      transaction and/or asset characteristics;

    4. (d)

      strength of the sponsor and developer including any public private partnership income stream; and

    5. (e)

      security package.

  2. (2)

    A firm must slot exposures into the five columns in the tables in BIPRU 4.5.9 R and BIPRU 4.5.13 R as follows:

    1. (a)

      a firm must slot an exposure categorised as strong under Annex X into column 1;

    2. (b)

      a firm must slot an exposure categorised as good under the Annex X into column 2;

    3. (c)

      a firm must slot an exposure categorised as satisfactory under Annex X into column 3;

    4. (d)

      a firm must slot an exposure categorised as weak under Annex X into column 4;

    5. (e)

      in accordance with BIPRU 4.5.5 R a firm must slot an exposure in default into column 5.

[Note:BCD Annex VII Part 1 point 6 (part)]

Calculation of risk-weighted exposure amounts

BIPRU 4.5.7 R

Notwithstanding BIPRU 4.3.5 R (Use of relevant parameters for calculating risk weighted exposure amounts), the calculation of risk weighted exposure amounts for credit risk for specialised lending exposures may be calculated in accordance with BIPRU 4.5.8 R.

[Note:BCD Article 87(5)]

BIPRU 4.5.8 R

For specialised lending exposures in respect of which a firm cannot demonstrate that its PD estimates meet the minimum IRB standards it must assign risk weights to these exposures according to the table in BIPRU 4.5.9 R.

[Note:BCD Annex VII Part 1 point 6 (part)]

BIPRU 4.5.9 R

Table: Risk weights for specialised lending

This table belongs to BIPRU 4.5.8 R1

Remaining maturity

Category 1 (Strong)

Category 2 (Good)

Category 3 (Satisfactory)

Category 4 (Weak)

Category 5

Less than 2.5 years

50%

70%

115%

250%

0%

Equal or more than 2.5 years

70%

90%

115%

250%

0%

The coverage of each of the categories is set out in BIPRU 4.5.6 R

[Note:BCD Annex VII Part 1 point 6 (part)]

BIPRU 4.5.10 R

A firm may generally assign preferential risk weights of 50% to exposures in category 1, and a 70% risk weight to exposures in category 2 if:

  1. (1)

    its IRB permission allows this; and

  2. (2)

    the firm's underwriting characteristics and other risk characteristics are substantially strong for the relevant category.

[Note:BCD Annex VII Part 1 point 6 (part)]

BIPRU 4.5.11 G
  1. (1)

    If a firm applies for an IRB permission or for a variation of an IRB permission that permits the treatment in BIPRU 4.5.10 R it should demonstrate that its standards exceed those of the slotting criteria provided for in BIPRU 4.5 and result in ratings that are stronger than the benchmarks referred to in (3).

  2. (2)

    If a firm has an IRB permission that permits the treatment in BIPRU 4.5.10 R it should continue to be able to demonstrate the matters in (1) to the appropriate regulator if asked.

  3. (3)

    Although a firm should map its internal ratings to the supervisory categories set out in the table in BIPRU 4.5.9 R using the slotting criteria provided in BIPRU 4.5.6 R, each supervisory category broadly corresponds to a range of external credit assessments of BBB- or better, BB+ or BB, BB- or B+ and B to C- (or their equivalents). The fifth category covers default.

Calculation of expected loss amounts

BIPRU 4.5.12 R

The EL values for specialised lending exposures where a firm uses the methods set out in BIPRU 4.5.8 R for assigning risk weights must be assigned according to the table in BIPRU 4.5.13 R.

[Note:BCD Annex VII Part 1 point 31 (part)]

BIPRU 4.5.13 R

Table: Expected loss values for specialised lending

This table belongs to BIPRU 4.5.12 R

Remaining maturity

Category 1 (Strong)

Category 2 (Good)

Category 3 (Satisfactory)

Category 4 (Weak)

Category 5

Less than 2.5 years

0%

0.4%

2.8%

8%

50%

Equal or more than 2.5 years

0.4%

0.8%

2.8%

8%

50%

The coverage of each of the categories is set out in BIPRU 4.5.6 R

[Note:BCD Annex VII Part 1 point 31 (part)]

BIPRU 4.5.14 R

Where a firm'sIRB permission authorises it generally to assign preferential risk weights as outlined in BIPRU 4.5.10 R of 50% to exposures in category 1, and 70% to exposures in category 2, the EL value for exposures in category 1 must be 0%, and for exposures in category 2 must be 0.4%.

[Note:BCD Annex VII Part 1 point 31 (part)]

BIPRU 4.6 The IRB approach: Retail exposures

Application

BIPRU 4.6.1 R

BIPRU 4.6 applies with respect to the exposures referred to in BIPRU 4.6.2 R.

Definition of retail exposures

BIPRU 4.6.2 R

To be eligible to be treated as a retail exposure, exposures must meet the following criteria:

  1. (1)

    they must be either to an individual person or persons, or to a small or medium sized entity, provided in the latter case that the total amount owed to the firm and parent undertaking and its subsidiary undertakings, including any past due exposure, by the obligor client or group of connected clients, but excluding claims or contingent claims secured on residential real estate collateral, must not, to the knowledge of the firm, which must have taken reasonable steps to confirm the situation, exceed EUR 1 million;

  2. (2)

    they are treated by the firm in its risk management consistently over time and in a similar manner;

  3. (3)

    they are not managed just as individually as exposures in the corporate exposureIRB exposure class;and

  4. (4)

    they each represent one of a significant number of similarly managed exposures.

[Note:BCD Article 86(4) (part)]

BIPRU 4.6.3 R

The present value of retail minimum lease payments is eligible to be treated as a retail exposure.

[Note:BCD Article 86(4) (part)]

BIPRU 4.6.4 G
  1. (1)

    This paragraph sets out guidance on BIPRU 4.6.2 R so far as it relates to the boundary between retail exposures and corporate exposures.

  2. (2)

    In deciding what steps are reasonable for the purposes of BIPRU 4.6.2 R (1), a firm may take into account complexity and cost, as well as the materiality of the impact upon its capital calculation. A firm should be able to demonstrate to the appropriate regulator that it has complied with the obligation to take reasonable steps under BIPRU 4.6.2 R (1) in the way it takes these factors into account.

  3. (3)

    If a firm has exposures to an owner of a retail SME in his personal capacity and exposures to the retail SME the firm should aggregate the two types of exposure for the purpose of BIPRU 4.6.2 R (1), although it should not include claims secured on residential real estate collateral. In deciding what steps are reasonable for the purposes of BIPRU 4.6.2 R (1) in aggregating these two types of exposure, a firm may take into account the materiality of those personal exposures. A firm should be able to demonstrate to the appropriate regulator that it has complied with the obligation to take reasonable steps under BIPRU 4.6.2 R (1) when taking into account materiality in this way.

  4. (4)

    The definition of group of connected clients is set out in the glossary. Paragraph (2) of that definition is "two or more persons ... who are to be regarded as constituting a single risk because they are so interconnected that, if one of them were to experience financial problems, the other or all of the others would be likely to encounter repayment difficulties". Say that a firm has exposures to A and B. When deciding whether A and B come within paragraph (2) of the definition two conditions should be satisfied. Firstly the connections between A and B should mean that if A experiences financial problems, B should be likely to encounter repayment difficulties. Secondly, the connections between A and B should mean that if B experiences financial problems, A should be likely to encounter repayment difficulties

  5. (5)

    A firm should have its own documented policy on the types of exposures that, in accordance with BIPRU 4.6, qualify as retail SME exposures. The appropriate regulator would not expect that a definition based on the EUR 1m exposure limit would be adequate on its own.

  6. (6)

    The purpose of the definition of retail exposure is to separate a non-granular retail and small and medium sized business portfolio from other business so that a separate capital calculation may be applied to that portfolio that takes into account its non-granularity. Where retail exposures are assigned to pools it is the statistical characteristics of these pools which are used to derive the IRB approach estimates. Therefore pools should be reasonably homogenous and subject to consistent risk management practices.

  7. (7)

    A firm should have sufficient controls to ensure that any inadvertent assignment of non-eligible exposures to the retail exposureIRB exposure class is sufficiently immaterial that it does not result in any significant distortion of the overall statistical characteristics of the sub-sets of that IRB exposure class which arise when the exposures are assigned to grades or pools. Cost considerations do not justify inclusion of non-eligible exposures if the effect would be material. Sample testing could be one method of demonstrating that the impact would be immaterial. BIPRU 4.1.25 R applies to exposures treated in accordance with this sub-paragraph (7).

  8. (8)

    If an exposure to a small or medium sized business crosses the retail exposure size boundary it should be treated as a corporate, unless, in accordance with BIPRU 4.1.25 R, the excess is immaterial because of its size or because it is temporary.

  9. (9)

    BIPRU 4.6.2 R does not require that exposures to retail SMEs should never be individually managed. In deciding whether the frequency and extent of individual management does or does not make exposures ineligible for the retail exposureIRB exposure class, a firm should consider whether that individual management is:

    1. (a)

      sufficiently insignificant not to disrupt the homogeneity of the pool;

    2. (b)

      consistent with the management of other exposures in the same retail exposure pool; and

    3. (c)

      significantly different in extent from the individual management that occurs for corporate exposures, looked at as a whole.

  10. (10)

    Where an exposure is denominated in other currencies, a firm may calculate the Euro equivalent for the purposes of BIPRU 4.6.2 R (1) using any appropriate set of exchange rates provided its choice has no obvious bias and that the firm is consistent in its approach to choosing rates.

  11. (11)

    A firm may monitor compliance with the €1m threshold in BIPRU 4.6.2 R (1) on the basis of approved limits provided that it has internal control procedures that are sufficient to ensure that amounts owed cannot diverge from those approved limits to such an extent as to give rise to a breach of the €1m threshold or, if the firm is relying on provisions relating to reasonable steps in BIPRU 4.6.2 R (1), any material breach of that threshold.

Rating system: Structure of rating system

BIPRU 4.6.5 G

Further material on the structure of rating systems can be found in BIPRU 4.3.25 R - BIPRU 4.3.28 R.

Rating system: Assignment to grades or pools

BIPRU 4.6.6 R

Rating systems must reflect both obligor and transaction risk, and must capture all relevant obligor and transaction characteristics.

[Note:BCD Annex VII Part 4 point 13]

BIPRU 4.6.7 R

The level of risk differentiation must ensure that the number of exposures in a given grade or pool is sufficient to allow for meaningful quantification and validation of the loss characteristics at the grade or pool level. The distribution of exposures and obligors across grades or pools must be such as to avoid excessive concentrations.

[Note:BCD Annex VII Part 4 point 14]

BIPRU 4.6.8 G
  1. (1)

    This paragraph contains guidance on the level of differentiation referred to in BIPRU 4.6.7 R.

  2. (2)

    It is important that a firm achieves adequate segmentation to deliver robust estimates of LGD and conversion factors, as well as PD. Whether the focus should be more on exposure size or collateral type is a question of fact for the particular circumstances in which the assignment of exposures to grades or pools occurs. Typically the appropriate regulator would expect both to be important.

  3. (3)

    A firm may allocate retail exposures to pools based on direct estimates of PD, LGD and conversion factors as well as using an approach under which the firm segments first and attributes PD, LGD and conversion factors afterwards. However the result should in either case be that the pools are sufficiently homogenous.

  4. (4)

    The number and size of pools should be determined in relation to the objective of establishing homogeneous risk. Pools should be of sufficient size to permit the production of robust risk estimates but should not be so large as to obscure variations in quality.

BIPRU 4.6.9 R

A firm must be able to demonstrate to the appropriate regulator that the process of assigning exposures to grades or pools provides for a meaningful differentiation of risk, provides for a grouping of sufficiently homogenous exposures, and allows for accurate and consistent estimation of loss characteristics at grade or pool level.

[Note:BCD Annex VII Part 4 point 15 (part)]

BIPRU 4.6.10 G

For purchased receivables, BIPRU 4.8 contains material about assignment to grades or pools.

BIPRU 4.6.11 R
  1. (1)

    A firm must consider the following risk drivers when assigning exposures to grades or pools:

    1. (a)

      obligor risk characteristics;

    2. (b)

      transaction risk characteristics, including product or collateral types or both; and

    3. (c)

      delinquency.

  2. (2)

    In the case of (1)(b) a firm must explicitly address cases where several exposures benefit from the same collateral.

  3. (3)

    However:

    1. (a)

      a firm need not consider delinquency if this is compatible with its IRB permission; and

    2. (b)

      (in the case of a firm with an IRB permission that permits the firm not to consider delinquency) it should be able to demonstrate to the appropriate regulator that delinquency is not a material risk driver for the exposures treated in this way.

[Note:BCD Annex VII Part 4 Point 16]

Rating system: Assignment of exposures

BIPRU 4.6.12 R

Each exposure must be assigned to a grade or a pool as part of the credit approval process.

[Note:BCD Annex VII Part 4 point 24]

Rating system: Overrides

BIPRU 4.6.13 G

Material on overrides can be found in BIPRU 4.3.50 R.

Rating system: Integrity of assignment process

BIPRU 4.6.14 R

A firm must at least annually update obligor and facility assignments or review the loss characteristics and delinquency status of each identified risk pool whichever is applicable. A firm must also at least annually review in a representative sample the status of individual exposures within each pool as a means of ensuring that exposures continue to be assigned to the correct pool.

[Note:BCD Annex VII Part 4 point 29]

BIPRU 4.6.15 G

Annual rescoring is one method of meeting the requirement in BIPRU 4.6.14 R. However a firm need not carry out this update by means of a full re-run of a credit scoring model if it is able to demonstrate that its method is appropriate to the portfolio given its materiality and its impact on its capital requirements and that the firm still meets the minimum IRB standards.

Rating system: Use of models

BIPRU 4.6.16 G

Material on the use of models can be found in BIPRU 4.3.51 R - BIPRU 4.3.53 G.

Rating system: Documentation

BIPRU 4.6.17 G

Material on documentation can be found in BIPRU 4.3.19 R - BIPRU 4.3.24 R.

Rating system: Data maintenance

BIPRU 4.6.18 R

In addition to complying with BIPRU 4.3.54 R (Data maintenance) a firm must collect and store:

  1. (1)

    data used in the process of allocating exposures to grades or pools;

  2. (2)

    data on the estimated PDs, LGDs and conversion factors associated with grades or pools of exposures;

  3. (3)

    the identity of obligors and exposures that defaulted;

  4. (4)

    for defaultedexposures, data on the grades or pools to which the exposure was assigned over the year prior to default and the realised outcomes on LGD and conversion factor; and

  5. (5)

    data on loss rates for qualifying revolving retail exposures.

[Note:BCD Annex VII Part 4 point 39]

Risk quantification: Definition of default

BIPRU 4.6.19 G

Material on the definition of default can be found in BIPRU 4.3.56 R - BIPRU 4.3.72 G.

BIPRU 4.6.20 R
  1. (1)

    This rule, in accordance with BIPRU 4.3.57 R (4) (Definition of default), sets the exact number of days past due that a firm must abide by in the case of retail exposures.

  2. (2)

    For retail exposures to counterparts situated within the United Kingdom the number of days past due is 180 days with the exception of retail SME exposures. For these exposures the number is 90 days.

  3. (3)

    For retail exposures to counterparts situated in another EEA State the number of days past due is the lower of:

    1. (a)

      180; and

    2. (b)

      the number of days past due fixed under the CRD implementation measure in that EEA State with respect to paragraph 48 of Part 4 of Annex VII of the Banking Consolidation Directive for such exposures.

  4. (4)

    For retail exposures to counterparts in a state outside the EEA the number of days past due is the lower of:

    1. (a)

      180; and

    2. (b)

      (if a number of days past due for such exposures has been fixed under any national law of that state applicable to undertakings in the banking sector or the investment services sector that implements the IRB approach) that number.

[Note:BCD Annex VII Part 4 point 44 (part) and point 48 (part)]

BIPRU 4.6.21 R

A firm may apply the definition of default at a facility level.

[Note:BCD Annex VII Part 4 point 44 (part)]

BIPRU 4.6.22 G

Where a firm chooses to apply the definition of default at facility level and a customer has defaulted on a facility, then default on that facility is likely to influence the PD assigned to that customer on other facilities and so should be taken into account.

Risk quantification: Overall requirements for estimation

BIPRU 4.6.23 G

Material on the overall requirements for estimation can be found in BIPRU 4.3.73 R - BIPRU 4.3.94 R.

Risk quantification: Requirements specific to PD estimation

BIPRU 4.6.24 R

A firm must estimate PDs by obligor grade or pool from long run averages of one-year default rates.

[Note:BCD Annex VII Part 4 point 67]

BIPRU 4.6.25 R

Notwithstanding BIPRU 4.6.24 R, PD estimates may also be derived from realised losses and appropriate estimates of LGDs.

[Note:BCD Annex VII Part 4 point 68]

BIPRU 4.6.26 R

A firm must regard internal data for assigning exposures to grades or pools as the primary source of information for estimating loss characteristics. A firm may use external data (including pooled data) or statistical models for quantification provided a strong link can be demonstrated between:

  1. (1)

    the firm's process of assigning exposures to grades or pools and the process used by the external data source; and

  2. (2)

    the firm's internal risk profile and the composition of the external data.

[Note:BCD Annex VII Part 4 point 69]

BIPRU 4.6.27 R

If a firm derives long run average estimates of PD and LGD for retail exposures from an estimate of total losses, and an appropriate estimate of PD or LGD, the process for estimating total losses must meet the minimum IRB standards1 for estimation of PD and LGD, and the outcome must be consistent with the concept of LGD as set out in BIPRU 4.3.99 R (Default weighted average).

[Note:BCD Annex VII Part 4 point 70]

BIPRU 4.6.28 R

Irrespective of whether a firm is using external, internal, pooled data sources or a combination of the three, for its estimation of loss characteristics, the length of the underlying historical observation period used must be at least five years for at least one source. If the available observation spans a longer period for any source, and these data are relevant, this longer period must be used. However:

  1. (1)

    a firm need not give equal importance to historic data if this is compatible with its IRB permission; and

  2. (2)

    (in the case of a firm with an IRB permission that permits this treatment of historic data) the firm must be able to convince the appropriate regulator that more recent data is a better predictor of loss rates.

[Note:BCD Annex VII Part 4 point 71 (part)]

BIPRU 4.6.29 R

A firm may have, when implementing the IRB approach, relevant data covering a period of two years. The period to be covered must increase by one year each year until relevant data covers a period of five years.

[Note:BCD Annex VII Part 4 point 71 (part)]

BIPRU 4.6.30 R

A firm must identify and analyse expected changes of risk parameters over the life of credit exposures (seasoning effects).

[Note:BCD Annex VII Part 4 point 72]

Risk quantification: Requirements specific to own-LGD estimation

BIPRU 4.6.31 R

Notwithstanding BIPRU 4.3.99 R (Default weighted average), LGD estimates may be derived from realised losses and appropriate estimates of PDs.

[Note:BCD Annex VII Part 4 point 83]

BIPRU 4.6.32 R

Notwithstanding BIPRU 4.3.128 R (Additional drawings), a firm may reflect future drawings either in its conversion factor or in its LGD estimates.

[Note:BCD Annex VII Part 4 point 84]

BIPRU 4.6.33 R

Estimates of LGD must be based on data over a minimum of five years. Notwithstanding BIPRU 4.3.99 R (Default weighted average):

  1. (1)

    a firm need not give equal importance to historic data if this is permitted by its IRB permission; and

  2. (2)

    (in the case of a firm with an IRB permission that permits this treatment of historic data) the firm must be able to convince the appropriate regulator that more recent data is a better predictor of loss rates.

[Note:BCD Annex VII Part 4 point 86 (part)]

BIPRU 4.6.34 R

A firm may have, when it implements the IRB approach, relevant data covering a period of two years. The period to be covered must increase by one year each year until relevant data covers a period of five years.

[Note:BCD Annex VII Part 4 point 86 (part)]

BIPRU 4.6.35 G

The appropriate regulator does not assume that all portfolios are sensitive to downturns. The appropriate regulator also accepts that for some portfolios, particularly in unsecured lending, the impact of the material drivers on LGD may be weak. However the burden is on the firm to demonstrate that its models are appropriate for the circumstances in which they are applied.

BIPRU 4.6.36 G

Additional material on requirements specific to own-LGD estimation can be found in BIPRU 4.3.98 R - BIPRU 4.3.123 R.

Risk quantification: Requirements specific to own-conversion factor estimates

BIPRU 4.6.37 R

Notwithstanding BIPRU 4.3.128 R (Additional drawings), a firm may reflect future drawings either in its conversion factors or in its LGD estimates.

[Note:BCD Annex VII Part 4 point 94]

BIPRU 4.6.38 R

Estimates of conversion factors must be based on data over a minimum of five years. Notwithstanding BIPRU 4.3.125 R:

  1. (1)

    a firm need not give equal importance to historic data if this is permitted by its IRB permission; and

  2. (2)

    (in the case of a firm with an IRB permission that permits this treatment of historic data) the firm must be able to convince the appropriate regulator if asked that more recent data is a better predictor of loss rates.

[Note:BCD Annex VII Part 4 point 95 (part)]

BIPRU 4.6.39 R

A firm may have, when it implements the IRB approach, relevant data covering a period of two years. The period to be covered must increase by one year each year until relevant data cover a period of five years.

[Note:BCD Annex VII Part 4 point 95 (part)]

BIPRU 4.6.40 G

Additional material on requirements specific to own-conversion factor estimation can be found in BIPRU 4.3.124 R - BIPRU 4.3.131 R.

Calculation of risk weighted exposure amounts for retail exposures: General

BIPRU 4.6.41 R

Subject to BIPRU 4.6.43 R and BIPRU 4.6.44 R, the risk weighted exposure amounts for retail exposures must be calculated according to the formulae in the table in BIPRU 4.6.42 R.

[Note:BCD Annex VII Part 1 point 10 1st sentence]

BIPRU 4.6.42 R

Table: Risk weighted exposure amounts for retail exposures

This table belongs to BIPRU 4.6.41 R

Correlation (R)

0.03 × (1 - EXP(-35*PD))/(1-EXP(-35)) + 0.16*

[1-(1-EXP(-35*PD))/(1-EXP(-35))]

Risk weight (RW)

(LGD*N[(1-R)-0.5*G(PD)+(R/(1-R))0.5 *G(0.999)]-PD*LGD)* 12.5*1.06

N(x)

denotes the cumulative distribution function for a standard normal random variable (i.e. the probability that a normal random variable with mean zero and variance of one is less than or equal to x).

G(z)

denotes the inverse cumulative distribution function for a standard normal random variable (i.e. the value x such that N(x) = z).

PD = 1

For PD = 1 (defaultedexposure), RW must be:

Max {0, 12.5 *(LGD- ELBE)}

where ELBEmust be the firm's best estimate of expected loss for the defaultedexposure according to BIPRU 4.3.122 R.

Risk weighted exposure amount

equals RW*exposure value

[Note:BCD Annex VII Part 1 point 10 (part)]

Calculation of risk weighted exposure amounts for retail exposures: Retail mortgages

BIPRU 4.6.43 R

For retail exposures secured by real estate collateral a correlation (R) of 0.15 must replace the correlation formula in the table in BIPRU 4.6.42 R.

[Note:BCD Annex VII Part 1 point 12]

Calculation of risk weighted exposure amounts for retail exposures: Qualifying revolving retail exposures

BIPRU 4.6.44 R
  1. (1)

    For qualifying revolving retail exposures a correlation (R) of 0.04 must replace the correlation formula in the table in BIPRU 4.6.42 R.

  2. (2)

    Retail exposures qualify as qualifying revolving retail exposures if they meet the following conditions:

    1. (a)

      the IRB permission of the firm in question does not disapply this paragraph;

    2. (b)

      the exposures are to individuals;

    3. (c)

      the exposures are revolving, unsecured, and, to the extent they are not drawn, immediately and unconditionally cancellable by the firm;

    4. (d)

      the maximum exposure to a single individual in the sub-portfolio is EUR 100,000 or less;

    5. (e)

      the firm is able to demonstrate to the appropriate regulator that the use of the correlation formula in this paragraph is limited to portfolios that have exhibited low volatility of loss rates, relative to their average level of loss rates, especially within the low PD bands; and

    6. (f)

      the firm is able to demonstrate to the appropriate regulator that treatment as a qualifying revolving retail exposure is consistent with the underlying risk characteristics of the sub-portfolio.

  3. (3)

    In the context of this rule revolving exposures are defined as those where customers' outstanding balances are permitted to fluctuate based on their decisions to borrow and repay, up to a limit established by the firm in question. Undrawn commitments may be considered as unconditionally cancellable if the terms permit the firm to cancel them to the full extent allowable under consumer protection and related legislation.

[Note:BCD Annex VII Part 1 point 13 (part) and Part 3 point 9(a) (part)]

BIPRU 4.6.45 G

A firm should be able to demonstrate the low volatility of loss rates mentioned in BIPRU 4.6.44 R (2)(e) at the time of the initial application for an IRB permission and thereafter at any time on request. The benchmark level should be the volatility of loss rates for the qualifying revolving retail exposure portfolio relative to the volatilities of loss rates of other relevant types of retail exposures. A firm should demonstrate low volatility by reference to data on the mean and standard deviation of loss rates over a time period that can be regarded as representative of the long-run performance of the portfolios concerned.

BIPRU 4.6.46 G

In the appropriate regulator's view a sub-portfolio consisting of credit card or overdraft obligations will usually meet the condition in BIPRU 4.6.44 R (2)(f). In the appropriate regulator's view it is unlikely that any other type of retail exposure will do so. If a firm wishes to apply the treatment in BIPRU 4.6.44 R (1) to product types other than credit card or overdraft obligations it should first discuss this with the appropriate regulator.

Calculation of expected loss amounts

BIPRU 4.6.47 R

Expected loss amounts must be calculated according to the formulae in the table in BIPRU 4.6.48 R.

[Note:BCD Annex VII Part 1 point 30 (part)]

BIPRU 4.6.48 R

Table: Formulae for the calculation of expected loss amounts

This table belongs to BIPRU 4.6.47 R

Expected loss (EL)

equals PD×LGD

Expected loss amount

equals EL×exposure value

For defaultedexposures (PD = 1) where a firm uses its own estimates of LGDs, EL must be ELBE, the firm's best estimate of expected loss for the defaultedexposure according to BIPRU 4.3.122 R.

For exposures subject to the treatment set out in BIPRU 4.4.79 R (Double default) EL must be 0.

[Note:BCD Annex VII Part 1 point 30 (part)]

Calculation of PDs

BIPRU 4.6.49 R

A firm must provide its own estimates of PDs in accordance with its IRB permission and the minimum IRB standards.

[Note: BCD Article 87(6) (part)]

BIPRU 4.6.50 R

The PD of an exposure must be at least 0.03%.

[Note:BCD Annex VII Part 2 point 17]

BIPRU 4.6.51 R

The PD of obligors in default must be 100%. If a firm is using the facility level approach described in BIPRU 4.6.21 R, the PD of an exposure in default must be 100%.

[Note:BCD Annex VII Part 2 point 18]

BIPRU 4.6.52 R

Unfunded credit protection may be recognised by adjusting PDs subject to BIPRU 4.6.54 R. For dilution risk, where a firm does not use its own estimates of LGDs, this must be subject to compliance with BIPRU 5 (Credit risk mitigation) modified by BIPRU 4.10 and, for this purpose, a firm may recognise unfunded credit protection providers other than those indicated in the CRM eligibility conditions provided the firm is able to demonstrate that the unfunded protection provider giving the undertaking is sufficiently reliable and that the protection agreement is legally effective in accordance with BIPRU 5.2.7 R (Unfunded credit protection).

[Note:BCD Annex VII Part 2 point 20]

Calculation of LGDs

BIPRU 4.6.53 R

A firm must provide its own estimates of LGDs in accordance with its IRB permission and the minimum IRB standards.

[Note: BCD Article 87(7) (part)]

BIPRU 4.6.54 R

Unfunded credit protection may be recognised as eligible by adjusting PD or LGD estimates subject to the minimum IRB standards as specified in BIPRU 4.10.43 R - BIPRU 4.10.48 R and in accordance with the IRB permission either in support of an individual exposure or a pool of exposures. A firm must not assign guaranteed exposures an adjusted PD or LGD such that the adjusted risk weight would be lower than that of a comparable, direct exposure to the guarantor.

[Note:BCD Annex VII Part 2 point 22]

Calculation of exposure values and own conversion factors

BIPRU 4.6.55 R

Except where otherwise specified, BIPRU 4.4.37 R - BIPRU 4.4.39 R (Exposure value and conversion factors), BIPRU 4.4.45 R (AIRB conversion factors) and BIPRU 4.4.71 R - BIPRU 4.4.78 R (Calculation of exposure values for sovereigns, institutions and corporates) also apply to retail exposures.

BIPRU 4.6.56 R

A firm must provide its own estimates of conversion factors in accordance with its IRB permission and the minimum IRB standards.

[Note: BCD Article 87(7) (part)]

Double default

BIPRU 4.6.57 R

The risk weighted exposure amount for each exposure to retail SME as defined in BIPRU 4.6.2 R which meets the requirements set out in BIPRU 4.4.83 R and BIPRU 4.4.85 R may be calculated according to BIPRU 4.4.79 R (Double default).

[Note:BCD Annex VII Part 1 point 11]

BIPRU 4.6.58 R

Notwithstanding BIPRU 4.6.54 R for the purposes of BIPRU 4.4.80 R the LGD of a comparable direct exposure to the protection provider must either be the LGD associated with an unhedged facility to the guarantor or the unhedged facility of the obligor, depending upon whether in the event both the guarantor and obligor default during the life of the hedged transaction available evidence and the structure of the guarantee indicate that the amount recovered would depend on the financial condition of the guarantor or obligor, respectively.

[Note:BCD Annex VII Part 2 point 23]

BIPRU 4.7 The IRB approach: Equity exposures

Application

BIPRU 4.7.1 R

BIPRU 4.7 applies with respect to the exposures referred to in BIPRU 4.7.2 R.

Definition of equity exposures

BIPRU 4.7.2 R

The following exposures must be classed as equity exposures:

  1. (1)

    non-debt exposures conveying a subordinated, residual claim on the assets or income of the issuer; and

  2. (2)

    debt exposures the economic substance of which is similar to the exposures specified in (1).

[Note:BCD Article 86(2)]

Calculation of risk-weighted exposure amounts

BIPRU 4.7.3 R

Notwithstanding BIPRU 4.3.5 R (Relevant parameters), the calculation of risk weighted exposure amounts for credit risk for all exposures belonging to the equity exposureIRB exposure class must be calculated in accordance with one of the following ways:

  1. (1)

    the simple risk weight approach (see BIPRU 4.7.8 R;

  2. (2)

    the PD/LGD approach (see BIPRU 4.7.13 R); and

  3. (3)

    the internal models approach (see BIPRU 4.7.23 R);

in accordance with BIPRU 4.7 and subject to the firm'sIRB permission.

[Note:BCD Article 87(4) (part)]

BIPRU 4.7.4 R

Even if a firm'sIRB permission would otherwise permit the use of the internal models approach as referred to in BIPRU 4.7.3 R (3), it may only use that approach if it meets the minimum requirements in BIPRU 4.7.27 R - BIPRU 4.7.35 R.

[Note:BCD Article 87(4) (part)]

BIPRU 4.7.5 R

A firm may employ different approaches to different portfolios where the firm itself uses different approaches internally. A firm must, if it uses different approaches in accordance with the previous sentence, be able to demonstrate to the appropriate regulator that the choice is made consistently and is not determined by regulatory arbitrage considerations.

[Note:BCD Annex VII Part 1 point 17]

BIPRU 4.7.6 R

Notwithstanding BIPRU 4.7.5 R a firm may, if its IRB permission permits it to do so, attribute the risk weighted exposure amounts for equity exposures to ancillary services undertakings according to the treatment of non credit-obligation assets.

[Note:BCD Annex VII Part 1 point 18]

Exposure value

BIPRU 4.7.7 R

The exposure value must be the value presented in the financial statements. Admissible equity exposure measures are the following:

  1. (1)

    for investments held at fair value with changes in value flowing directly through income and into capital resources, the exposure value is the fair value presented in the balance sheet;

  2. (2)

    for investments held at fair value with changes in value not flowing through income but into a tax-adjusted separate component of equity, the exposure value is the fair value presented in the balance sheet; and

  3. (3)

    for investments held at cost or at the lower of cost or market value, the exposure value is the cost or market value presented in the balance sheet.

[Note:BCD Annex VII Part 3 point 12]

The calculation of risk-weighted exposure amounts for equity exposures: The simple risk weight approach: Introduction

BIPRU 4.7.8 R

BIPRU 4.7.9 R to BIPRU 4.7.12 R set out the simple risk weight approach for calculating the risk weighted exposure amounts for equity exposures as referred to in BIPRU 4.7.3 R (1).

The calculation of risk-weighted exposure amounts for equity exposures: The simple risk weight approach: Risk weighted exposure amounts

BIPRU 4.7.9 R

The risk weighted exposure amounts must be calculated according to the following formula:

risk-weighted exposure amounts = RW * exposure value;

where:

  1. (1)

    risk weight (RW) = 190% for private equity exposures in sufficiently diversified portfolios;

  2. (2)

    risk weight (RW) = 290% for exchange traded equity exposures; and

  3. (3)

    risk weight (RW) = 370% for all other equity exposures.

[Note:BCD Annex VII Part 1 point 19]

BIPRU 4.7.10 R

Short cash positions and derivative instruments held in the non-trading book are permitted to offset long positions in the same individual stocks provided that these instruments have been explicitly designated as hedges of specific equity exposures and that they provide a hedge for at least another year. Other short positions must be treated as if they are long positions with the relevant risk weight assigned to the absolute value of each position. In the context of maturity mismatched positions, the method is that for corporate exposures as set out in BIPRU 4.4.70 R.

[Note:BCD Annex VII Part 1 point 20]

BIPRU 4.7.11 R

A firm may recognise unfunded credit protection obtained on an equity exposure in accordance with the methods set out in BIPRU 5 (Credit risk mitigation), as modified by BIPRU 4.10.

[Note:BCD Annex VII Part 1 point 21]

The calculation of risk-weighted exposure amounts for equity exposures: The simple risk weight approach: Expected loss

BIPRU 4.7.12 R

The expected loss amounts1 for equity exposures must be calculated according to the following formula:

  1. (1)

    expected loss amount = EL × exposure value; and

  2. (2)

    the EL values must be the following:

    1. (a)

      expected loss (EL) = 0.8% for private equity exposures in sufficiently diversified portfolios;

    2. (b)

      expected loss (EL) = 0.8% for exchange traded equity exposures; and

    3. (c)

      expected loss (EL) = 2.4% for all other equity exposures.

[Note:BCD Annex VII Part 1 point 32]

The calculation of risk-weighted exposure amounts for equity exposures: The PD/LGD approach: Introduction

BIPRU 4.7.13 R

The calculation of risk-weighted exposure amounts for equity exposures: The PD/LGD approach: Risk weighted exposure amounts

BIPRU 4.7.14 R

The risk weighted exposure amounts must be calculated according to the formulas in BIPRU 4.4.58 R (Risk weighted exposure amounts for sovereigns, institutions and corporates). If a firm does not have sufficient information to use the definition of default a scaling factor of 1.5 must be assigned to the risk weights.

[Note:BCD Annex VII Part 1 point 22]

BIPRU 4.7.15 R

At the individual exposure level the sum of the expected loss amount multiplied by 12.5 and the risk weighted exposure amount must not exceed the exposure value multiplied by 12.5.

[Note:BCD Annex VII Part 1 point 23]

BIPRU 4.7.16 R

A firm may recognise unfunded credit protection obtained on an equity exposure in accordance with the methods set out in BIPRU 5 (Credit risk mitigation) as modified by BIPRU 4.10. This must be subject to an LGD of 90% on the exposure to the provider of the hedge. For private equity exposures in sufficiently diversified portfolios an LGD of 65% may be used.

[Note:BCD Annex VII Part 1 point 24]

The calculation of risk-weighted exposure amounts for equity exposures: The PD/LGD approach: Calculation of expected loss amounts

BIPRU 4.7.17 R

The expected loss amounts for equity exposures must be calculated according to the following formulae:

  1. (1)

    expected loss (EL) = PD × LGD; and

  2. (2)

    expected loss amount = EL × exposure value.

[Note:BCD Annex VII Part 1 point 33]

The calculation of risk-weighted exposure amounts for equity exposures: The PD/LGD approach: PDs

BIPRU 4.7.18 R

PDs must be determined according to the methods for corporate exposures. The following minimum PDs must be applied:

  1. (1)

    0.09% for exchange traded equity exposures where the investment is part of a long-term customer relationship;

  2. (2)

    0.09% for non-exchange traded equity exposures where the returns on the investment are based on regular and periodic cash flows not derived from capital gains;

  3. (3)

    0.40% for exchange traded equity exposures including other short positions as set out in BIPRU 4.7.10 R; and

  4. (4)

    1.25% for all other equity exposures including other short positions as set out in BIPRU 4.7.10 R.

[Note:BCD Annex VII Part 2 point 24]

BIPRU 4.7.19 R

BIPRU 4.4.29 G (five year observation period) applies to the PD/LGD approach.

[Note:BCD Annex VII Part 4 point 66 (part)]

The calculation of risk-weighted exposure amounts for equity exposures: The PD/LGD approach: LGDs

BIPRU 4.7.20 R

Private equity exposures in sufficiently diversified portfolios may be assigned an LGD of 65%.

[Note:BCD Annex VII Part 2 point 25]

BIPRU 4.7.21 R

All other exposures must be assigned an LGD of 90%.

[Note:BCD Annex VII Part 2 point 26]

The calculation of risk-weighted exposure amounts for equity exposures: The PD/LGD approach: Maturity

BIPRU 4.7.22 R

M (maturity) assigned to all exposures must be 5 years.

[Note:BCD Annex VII Part 2 point 27]

The calculation of risk-weighted exposure amounts for equity exposures: The internal models approach: Introduction

BIPRU 4.7.23 R

BIPRU 4.7.24 R to BIPRU 4.7.35 R set out the internal models approach for calculating the risk weighted exposure amounts for equity exposures as referred to in BIPRU 4.7.3 R (3).

The calculation of risk-weighted exposure amounts for equity exposures: The internal models approach: Risk weighted exposure amounts

BIPRU 4.7.24 R

The risk weighted exposure amount is the potential loss on the firm'sequity exposures as derived using internal value-at-risk models subject to the 99th percentile, one-tailed confidence interval of the difference between quarterly returns and an appropriate risk-free rate computed over a long-term sample period, multiplied by 12.5. The risk weighted exposure amounts at the equity exposure portfolio2 level must not be less than the total of the sums2 of the minimum risk weighted exposure amounts required under the PD/LGD approach and the corresponding expected loss amounts1 multiplied by 12.5 and calculated on the basis of the PD values set out in BIPRU 4.7.18 R (1) and the corresponding LGD values set out in2BIPRU 4.7.20 R and BIPRU 4.7.21 R.

[Note:BCD Annex VII Part 1 point 25]

2 2
BIPRU 4.7.25 R

A firm may recognise unfunded credit protection obtained on an equityposition.

[Note:BCD Annex VII Part 1 point 26]

The calculation of risk weighted exposure amounts for equity exposures: The internal models approach: Expected loss amounts

BIPRU 4.7.26 R

The expected loss amounts for equity exposures under the internal models approach must be 0%.

[Note:BCD Annex VII Part 1 point 34]

The calculation of risk weighted exposure amounts for equity exposures: The internal models approach: Capital requirements and risk quantification

BIPRU 4.7.27 R
  1. (1)

    A firm must meet the standards set out in (2) to (9) for the purpose of calculating capital requirements.

  2. (2)

    The estimate of potential loss must be robust to adverse market movements relevant to the long-term risk profile of the firm's specific holdings. The data used to represent return distributions must reflect the longest sample period for which data is available and be meaningful in representing the risk profile of the firm's specific equity exposures. The data used must be sufficient to provide conservative, statistically reliable and robust loss estimates that are not based purely on subjective or judgmental considerations. A firm must be able to demonstrate to the appropriate regulator that the shock employed provides a conservative estimate of potential losses over a relevant long-term market or business cycle.

  3. (3)

    A firm must combine empirical analysis of available data with adjustments based on a variety of factors in order to attain model outputs that achieve appropriate realism and conservatism. In constructing Value at Risk (VaR) models estimating potential quarterly losses, a firm may use quarterly data or convert shorter horizon period data to a quarterly equivalent using an analytically appropriate method supported by empirical evidence and through a well-developed and documented thought process and analysis. Such an approach must be applied conservatively and consistently over time. Where only limited relevant data is available a firm must add appropriate margins of conservatism.

  4. (4)

    The models used must be able to capture adequately all of the material risks embodied in equity returns including both the general market risk and specific risk exposure of the firm'sequity exposure portfolio. The internal models must adequately explain historical price variation, capture both the magnitude and changes in the composition of potential concentrations, and be robust to adverse market environments. The population of risk exposures represented in the data used for estimation must be closely matched to or at least comparable with those of the firm'sequity exposures.

  5. (5)

    The internal model must be appropriate for the risk profile and complexity of a firm'sequity exposure portfolio. Where a firm has material holdings with values that are highly non-linear in nature the internal models must be designed to capture appropriately the risks associated with such instruments.

  6. (6)

    Mapping of individual positions to proxies, market indices, and risk factors must be plausible, intuitive, and conceptually sound.

  7. (7)

    A firm must be able to demonstrate to the appropriate regulator through empirical analyses the appropriateness of risk factors, including their ability to cover both general market risk and specific risk.

  8. (8)

    The estimates of the return volatility of equity exposures must incorporate relevant and available data, information, and methods. Independently reviewed internal data or data from external sources (including pooled data) must be used.

  9. (9)

    A rigorous and comprehensive stress-testing programme must be in place.

[Note:BCD Annex VII Part 4 point 115]

The calculation of risk-weighted exposure amounts for equity exposures: The internal models approach: Risk management and controls

BIPRU 4.7.28 R
  1. (1)

    With regard to the development and use of internal models for capital requirement purposes, a firm must establish policies, procedures, and controls to ensure the integrity of the model and modelling process. These policies, procedures, and controls must include the ones set out in the rest of this paragraph.

  2. (2)

    There must be full integration of the internal model into the overall management information systems of the firm and in the management of the non-trading bookequity exposure portfolio. In particular they must be used in:

    1. (a)

      measuring and assessing equity exposure portfolio performance (including the risk adjusted performance);

    2. (b)

      allocating economic capital to equity exposures; and

    3. (c)

      evaluating overall capital adequacy and the investment management process.

  3. (3)

    A firm must have established management systems, procedures, and control functions for ensuring the periodic and independent review of all elements of the internal modelling process, including approval of model revisions, vetting of model inputs, and review of model results, such as direct verification of risk computations. These reviews must assess the accuracy, completeness, and appropriateness of model inputs and results and focus on both finding and limiting potential errors associated with known weaknesses and identifying unknown model weaknesses. Such reviews may be conducted by an internal independent unit, or by an independent external third party.

  4. (4)

    There must be adequate systems and procedures for monitoring investment limits and the risk exposures of equity exposures.

  5. (5)

    The units responsible for the design and application of the model must be functionally independent from the units responsible for managing individual investments.

  6. (6)

    Parties responsible for any aspect of the modelling process must be adequately qualified. Management must allocate sufficient skilled and competent resources to the modelling function.

[Note:BCD Annex VII Part 4 point 116]

The calculation of risk-weighted exposure amounts for equity exposures: The internal models approach: Validation and documentation

BIPRU 4.7.29 R

A firm must have a robust system in place to validate the accuracy and consistency of its internal models and modelling processes. All material elements of the internal models and the modelling process and validation must be documented.

[Note:BCD Annex VII Part 4 point 117]

BIPRU 4.7.30 R

A firm must use the internal validation process to assess the performance of its internal models and processes in a consistent and meaningful way.

[Note:BCD Annex VII Part 4 point 118]

BIPRU 4.7.31 R

The methods and data used for quantitative validation must be consistent through time. Changes in estimation and validation methods and data (both data sources and periods covered) must be documented.

[Note:BCD Annex VII Part 4 point 119]

BIPRU 4.7.32 R

A firm must regularly compare actual equity exposure returns (computed using realised and unrealised gains and losses) with modelled estimates. Such comparisons must make use of historical data that cover as long a period as possible. A firm must document the methods and data used in such comparisons. This analysis and documentation must be updated at least annually.

[Note:BCD Annex VII Part 4 point 120]

BIPRU 4.7.33 R

A firm must make use of other quantitative validation tools and comparisons with 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. A firm's internal assessments of the performance of its models must be based on as long a period as possible.

[Note:BCD Annex VII Part 4 point 121]

BIPRU 4.7.34 R

A firm must have sound internal standards for situations where comparison of actual equity exposure returns with the models' estimates calls the validity of the estimates or of the models as such into question. These standards must take account of business cycles and similar systematic variability in equity exposure returns. All adjustments made to internal models in response to model reviews must be documented and consistent with the firm's model review standards.

[Note:BCD Annex VII Part 4 point 122]

BIPRU 4.7.35 R

The internal model and the modelling process must be documented, including the responsibilities of parties involved in the modelling, and the model approval and model review processes.

[Note:BCD Annex VII Part 4 point 123]

BIPRU 4.8 The IRB approach: Purchased receivables

Application

BIPRU 4.8.1 R

BIPRU 4.8 applies with respect to purchased receivables.

BIPRU 4.8.2 G

Purchased receivables do not form an IRB exposure class on their own. For any purchased receivable, the provisions of the sections of BIPRU 4 that deal with the IRB exposure class to which it belongs also apply, as modified by this section.

[Note: BCD Annex VII Part 4 point 15 (part)]

Structure of rating systems

BIPRU 4.8.3 R

For retail exposure that are purchased receivables, the grouping referred to in BIPRU 4.6.9 R must reflect the seller's underwriting practices and the heterogeneity of its customers.

Risk quantification: Overall requirements for estimation: General

BIPRU 4.8.4 G

Further general material about the requirements for estimation can be found in BIPRU 4.3.73 R - BIPRU 4.3.94 R.

BIPRU 4.8.5 R

The estimates for determining the risk parameters PD, LGD, conversion factor and EL must reflect all relevant information available to the purchasing firm regarding the quality of the underlying receivables, including data for similar pools provided by the seller, by the purchasing firm, or by external sources. The purchasing firm must evaluate any data relied upon which is provided by the seller.

[Note: BCD Annex VII Part 4 point 53]

Risk quantification: Overall requirements for estimation: Requirements specific to PD estimation

BIPRU 4.8.6 R

With respect to BIPRU 4.6.26 R (Internal and external data for PD estimation: retail exposures) a firm may use external and internal reference data for PD estimation. A firm must use all relevant data sources as points of comparison.

[Note: BCD Annex VII Part 4 point 69 (part)]

BIPRU 4.8.7 R

For corporate exposure purchased receivables a firm may estimate ELs by obligor grade from long run averages of one-year realised default rates.

[Note: BCD Annex VII Part 4 point 60]

BIPRU 4.8.8 R

If a firm derives long run average estimates of PDs and LGDs for corporate exposure purchased receivables from an estimate of EL, and an appropriate estimate of PD or LGD, the process for estimating total losses must meet the overall standards for estimation of PD and LGD set out in the minimum IRB standards,2 and the outcome must be consistent with the concept of LGD as set out in BIPRU 4.3.99 R.

[Note: BCD Annex VII Part 4 point 61]

Risk quantification: Overall requirements for estimation: Requirements specific to own-LGD estimates

BIPRU 4.8.9 R

A firm may use external and internal reference data for its LGD estimates in the case of retail exposures that are purchased receivables.

[Note: BCD Annex VII Part 4 point 85]

Risk quantification: Overall requirements for estimation: Minimum requirements for purchased receivables: General

BIPRU 4.8.10 R

BIPRU 4.8.11 R - BIPRU 4.8.15 R set out minimum requirements specific to the treatment of purchased receivables under the IRB approach.

Risk quantification: Overall requirements for estimation: Minimum requirements for purchased receivables: Legal certainty

BIPRU 4.8.11 R

The structure of the facility must ensure that under all foreseeable circumstances a firm has effective ownership and control of all cash remittances from the receivables. When the obligor makes payments directly to a seller or servicer a firm must verify regularly that payments are forwarded completely and within the contractually agreed terms. Servicer means an entity that manages a pool of purchased receivables or the underlying credit exposures on a day-to-day basis. A firm must have procedures to ensure that ownership over the receivables and cash receipts is protected against bankruptcy stays or legal challenges that could materially delay the lender's ability to liquidate or assign the receivables or retain control over cash receipts.

[Note: BCD Annex VII Part 4 point 105]

Risk quantification: Overall requirements for estimation: Minimum requirements for purchased receivables: Effectiveness of monitoring systems

BIPRU 4.8.12 R
  1. (1)

    A firm must monitor both the quality of the purchased receivables and the financial condition of the seller and servicer. In particular a firm must comply with the remaining provisions of this rule.

  2. (2)

    A firm must assess the correlation among the quality of the purchased receivables and the financial condition of both the seller and servicer, and 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.

  3. (3)

    A firm must have clear and effective policies and procedures for determining seller and servicer eligibility. A firm or its agent must conduct periodic reviews of sellers and servicers in order to verify the accuracy of reports from the seller or 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 documented.

  4. (4)

    A firm must assess the characteristics of the purchased receivables pools including:

    1. (a)

      over-advances;

    2. (b)

      history of the seller's arrears, bad debts, and bad debt allowances;

    3. (c)

      payment terms; and

    4. (d)

      potential contra accounts.

  5. (4)

    A firm must have effective policies and procedures for monitoring on an aggregate basis single-obligor concentrations both within and across purchased receivables pools.

  6. (5)

    A firm must ensure that it receives from the servicer timely and sufficiently detailed reports of receivables ageings and dilutions to ensure compliance with the firm's eligibility criteria and advancing policies governing purchased receivables, and provide an effective means with which to monitor and confirm the seller's terms of sale and dilution.

[Note: BCD Annex VII Part 4 point 106]

Risk quantification: Overall requirements for estimation: Minimum requirements for purchased receivables: Effectiveness of work-out systems

BIPRU 4.8.13 R

A firm must have systems and procedures for detecting deteriorations in the seller's financial condition and purchased receivables quality at an early stage, and for addressing emerging problems proactively. In particular a firm must have clear and effective policies, procedures, and information systems to monitor covenant violations, and clear and effective policies and procedures for initiating legal actions and dealing with problem purchased receivables.

[Note: BCD Annex VII Part 4 point 107]

Risk quantification: Overall requirements for estimation: Minimum requirements for purchased receivables: Effectiveness of systems for controlling collateral, credit availability and cash

BIPRU 4.8.14 R

A firm must have clear and effective policies and procedures governing the control of purchased 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 the way cash receipts are to be handled. These elements must take appropriate account of all relevant and material factors, including the seller's and servicer's financial condition, risk concentrations, and trends in the quality of the purchased receivables and the seller's customer base, and internal systems must ensure that funds are advanced only against specified supporting collateral and documentation.

[Note: BCD Annex VII Part 4 point 108]

Risk quantification: Overall requirements for estimation: Minimum requirements for purchased receivables: Compliance with the firm's internal policies and procedures

BIPRU 4.8.15 R

A firm must have an effective internal process for assessing compliance with all internal policies and procedures. The process must include regular audits of all critical phases of the firm's receivables purchase programme, verification of the separation of duties between, firstly, the assessment of the seller and servicer and the assessment of the obligor and, secondly, between the assessment of the seller and servicer and the field audit of the seller and servicer and evaluations of back office operations, with particular focus on qualifications, experience, staffing levels, and supporting automation systems.

[Note: BCD Annex VII Part 4 point 109]

Calculation of risk-weighted asset amounts: Eligibility for different treatments: Corporate exposures

BIPRU 4.8.16 R

For its corporate exposure purchased receivables a firm must comply with the minimum requirements set out in BIPRU 4.8.11 R - BIPRU 4.8.15 R. For corporate exposure purchased receivables that comply in addition with the conditions set out in BIPRU 4.8.18 R, and where it would be unduly burdensome for a firm to use the risk quantification standards for corporate exposures as set out in the minimum IRB standards for these receivables, the risk quantification standards for retail exposures as set out in the minimum IRB standards may be used.

[Note: BCD Annex VII Part 1 point 7]

BIPRU 4.8.17 R

For corporate exposure purchased receivables, refundable purchase discounts, collateral or partial guarantees that provide first-loss protection for defaultlosses, dilution losses, or both, may be treated as first-loss positions under the provisions in BIPRU 9 (Securitisation) about the IRB approach.

[Note: BCD Annex VII Part 1 point 8]

Calculation of risk weighted asset amounts: Eligibility for different treatments: Retail exposures

BIPRU 4.8.18 R

To be eligible for the retail exposure treatment purchased receivables must comply with the minimum requirements set out in BIPRU 4.8.11 R - BIPRU 4.8.15 R and the following conditions:

  1. (1)

    the firm has purchased the receivables from unrelated, third party sellers, and its exposure to the obligor of the receivable does not include any exposures that are directly or indirectly originated by the firm itself;

  2. (2)

    the purchased receivables must be generated on an arm's-length basis between the seller and the obligor (and as such, intercompany accounts receivables and receivables subject to contra-accounts between firms that buy and sell to each other are ineligible);

  3. (3)

    the purchasing firm has a claim on all proceeds from the purchased receivables or a pro-rata interest in the proceeds; and

  4. (4)

    the portfolio of purchased receivables is sufficiently diversified.

[Note: BCD Annex VII Part 1 point 14]

BIPRU 4.8.19 R

With respect to retail exposures, for purchased receivables, refundable purchase discounts, collateral or partial guarantees that provide first-loss protection for defaultlosses, dilution losses, or both, may be treated as first-loss positions under the provisions in BIPRU 9 (Securitisation) about the IRB approach.

[Note: BCD Annex VII Part 1 point 15]

BIPRU 4.8.20 R

For hybrid pools of purchased retail exposure receivables where the purchasing firm cannot separate exposures secured by real estate collateral and qualifying revolving retail exposures from other retail exposures, the retail risk weight2 function producing the highest capital requirements for those exposures must apply.

[Note: BCD Annex VII Part 1 point 16]

Calculation of risk weighted asset amounts for dilution risk

BIPRU 4.8.21 R

The risk weights for dilution risk for purchased receivables (both corporate exposures and retail exposures) must be calculated according to this rule. The risk weights must be calculated according to the formula in BIPRU 4.4.58 R. However, for the purposes of that formula, the total annual sales referred to in BIPRU 4.4.59 R are the weighted average by individual exposures of the pool. The input parameters PD and LGD and the exposure value must be determined under the applicable provisions of BIPRU 4 as modified by this section. M (maturity) must be 1 year. However:

  1. (1)

    a firm need not recognise dilution risk if its IRB permission permits this; and

  2. (2)

    (in the case of a firm with an IRB permission that permits the treatment of dilution risk in (1)) the firm must be able to convince the appropriate regulator that dilution risk is immaterial.

[Note: BCD Article 87(2) (part) and Annex VII Part 1 point 28]

Calculation of risk weighted exposure amounts: PDs

BIPRU 4.8.22 R

For purchased corporate exposure receivables in respect of which a firm cannot demonstrate that its PD estimates meet the minimum IRB standards, the PDs for these exposures must be determined according to the following methods:

  1. (1)

    for senior claims on purchased corporate exposure receivables PD must be the firm's estimate of EL divided by LGD for these receivables;

  2. (2)

    for subordinated claims on purchased corporate exposure receivables PD must be the firm's estimate of EL; and1

  3. (3)

    if a firm is under its IRB permission using the advanced IRB approach for LGD estimates for corporate exposures and it can decompose its EL estimates for purchased corporate exposure receivables into PDs and LGDs in a reliable manner, the LGD estimate may be used.

[Note: BCD Annex VII Part 2 point 3]

BIPRU 4.8.23 R

In the case of corporate exposures, for dilution risk of purchased receivables PD must be set equal to EL estimate for dilution risk. If a firm is under its IRB permission using the advanced IRB approach for LGD estimates for corporate exposures and it can decompose its EL estimates for dilution risk of purchased corporate exposure receivables into PDs and LGDs in a reliable manner, the PD estimate may be used. A firm may recognise unfunded credit protection in the PD in accordance with the provisions of BIPRU 9 and BIPRU 5 as modified by BIPRU 4.10. A firm may recognise those unfunded credit protection providers set out in its IRB permission in addition to those indicated in the CRM eligibility conditions. Where a firm'sIRB permission allows it to use its own LGD estimates for dilution risk of purchased corporate receivables, the firm may recognise unfunded credit protection by adjusting PDs subject to the provisions of BIPRU 4.4.43 R.

[Note: BCD Annex VII Part 2 point 7]

BIPRU 4.8.24 R

In the case of retail exposures, for dilution risk of purchased receivables PD must be set equal to EL estimates for dilution risk. If a firm can decompose its EL estimates for dilution risk of purchased receivables into PDs and LGDs in a reliable manner, the PD estimate may be used.

[Note: BCD Annex VII Part 2 point 19]

Calculation of risk weighted asset amounts: LGDs: Corporate exposures

BIPRU 4.8.25 R

The following LGD values apply for purchased corporate exposure receivables:

  1. (1)

    for senior purchased corporate exposure receivables exposures where a firm cannot demonstrate that its PD estimates meet the minimum IRB standards, the value is 45%;

  2. (2)

    for subordinated purchased corporate exposure receivables exposures where a firm cannot demonstrate that its PD estimates meet the minimum IRB standards, the value is 100%; and

  3. (3)

    for dilution risk of purchased corporate exposure receivables, the value is 75%.

[Note: BCD Annex VII Part 2 point 8(e) to (g)]1

BIPRU 4.8.26 R

Notwithstanding BIPRU 4.4.34 R and BIPRU 4.8.25 R, for dilution risk and default risk if a firm is under its IRB permission using the advanced IRB approach for LGD estimates for corporate exposures and it can decompose its EL estimates for purchased corporate exposure receivables into PDs and LGDs in a reliable manner, the LGD estimate for purchased corporate exposure receivables may be used.

[Note: BCD Annex VII Part 2 point 9]

Calculation of risk weighted asset amounts: LGDs: Retail exposures

BIPRU 4.8.27 R

For dilution risk of purchased retail exposure receivables an LGD value of 75% must be used. If a firm can decompose its EL estimates for dilution risk of purchased receivables into PDs and LGDs in a reliable manner, the LGD estimate may be used.

[Note: BCD Annex VII Part 2 point 21]

Calculation of risk weighted asset amounts: Exposure value

BIPRU 4.8.28 R

The exposure value for the calculation of risk weighted exposure amounts of purchased receivables must be the outstanding amount minus the capital requirements for dilution risk prior to credit risk mitigation.

[Note: BCD Annex VII Part 3 point 6]

BIPRU 4.8.29 R
  1. (1)

    The exposure value for the items in (2) must be calculated as the committed but undrawn amount multiplied by a conversion factor.

  2. (2)

    For undrawn purchase commitments for revolving purchased receivables that are unconditionally cancellable or that effectively provide for automatic cancellation at any time by the firm without prior notice, a conversion factor of 0% applies. To apply a conversion factor of 0%, a firm must actively monitor the financial condition of the obligor, and its internal control systems must enable it immediately to detect a deterioration in the credit quality of the obligor.

[Note:BCD Annex VII Part 3 point 9 (c)]

Calculation of expected loss amounts

BIPRU 4.8.30 R

The expected loss amounts for dilution risk of purchased receivables must be calculated according to the following formula:

[Note: BCD Article 88(5) and Annex VII Part 1 point 35]

BIPRU 4.9 The IRB approach: Securitisation, non-credit obligations assets and CIUs

Application

BIPRU 4.9.1 R

BIPRU 4.9 applies with respect to securitisationexposures, non credit-obligation assets and exposures to CIUs.

Securitisation exposures

BIPRU 4.9.2 R

The following must be calculated in accordance with BIPRU 9 (Securitisation):

  1. (1)

    risk-weighted exposure amounts for securitisedexposures and for exposures belonging to the IRB exposure class referred to in BIPRU 4.3.2 R (6) (securitisation positions); and

  2. (2)

    the expected loss amounts for securitisedexposures.

[Note: BCD Article 87(10) and Article 88(3)]

Provision of credit protection

BIPRU 4.9.3 R

Where a firm provides credit protection for a number of exposures under terms that the nth default among the exposures shall trigger payment and that this credit event shall terminate the contract, if the product has an external credit assessment from an eligible ECAI the risk weights set out in BIPRU 9 must be applied. If the product is not rated by an eligible ECAI, the risk weights of the exposures included in the basket must be aggregated, excluding n-1 exposures where the sum of the expected loss amount multiplied by 12.5 and the risk weighted exposure amount must not exceed the nominal amount of the protection provided by the credit derivative multiplied by 12.5. The n-1 exposures to be excluded from the aggregation must be determined on the basis that they must include those exposures each of which produces a lower risk weighted exposure amount than the risk weighted exposure amount of any of the exposures included in the aggregation.

[Note: BCD Annex VII Part 1 point 9]

Non credit obligation assets: Introduction

BIPRU 4.9.4 R

Non credit obligation assets: Inclusion of residual value of leases

BIPRU 4.9.5 R

The non credit obligation assetIRB exposure class includes the residual value of leased properties, if not included in the lease exposure as defined in BIPRU 4.4.75 R.

[Note: BCD Article 86(8)]

Non credit obligation assets: Risk weighted exposure amount

BIPRU 4.9.6 R

The risk weighted exposure amounts must be calculated according to the formula:

Risk-weighted exposure amount = 100% * exposure value except for when the exposure is a residual value of leased properties1 in which case it must1 be calculated as follows:

1/t * 100% * exposure value;where t is the greater of 1 and the nearest number of whole years of the lease remaining.1

[Note: BCD Annex VII Part 1 point 27]

1
BIPRU 4.9.7 G

t should be an integer number reflecting the nearest number of whole years of the lease remaining and should decrease as the lease matures so that the discounted value steps up gradually from a small value to 100% as the end of the lease approaches.

BIPRU 4.9.8 R

Where a firm has full recourse in respect of purchased receivables for default risk and for dilution risk, to the seller of the purchased receivables, BIPRU 4.8.21 R and BIPRU 4.8.30 R need not be applied. The exposure may instead be treated as a collateralised exposure.

[Note: BCD Article 87(2) (part)]

Non credit obligation assets: Exposure value

BIPRU 4.9.9 R

The exposure value of non credit-obligation assets must be the value presented in the financial statements.

[Note: BCD Annex VII Part 3 point 13]

Non credit obligation assets: Expected loss amounts

BIPRU 4.9.10 R

For non credit-obligation assets the expected loss amount must be zero.

[Note: BCD Article 88(4)]

Collective investment undertakings

BIPRU 4.9.11 R
  1. (1)

    Where exposures in the form of a CIU1 meet the criteria set out in BIPRU 3.4.121 R to BIPRU 3.4.122 R (Conditions for look through treatment under the standardised approach) and the firm is aware of all of the underlying exposures of the CIU, the firm must look through to those underlying exposures in order to calculate risk weighted exposure amounts and expected loss amounts in accordance with the methods set out in BIPRU 4.BIPRU 4.9.12 R applies to the part of the underlying exposures of the CIU of which the firm is not aware or could not reasonably be aware. In particular, BIPRU 4.9.12 R must apply where it would be unduly burdensome for the firm to look through the underlying exposures in order to calculate risk weighted exposure amounts and expected loss amounts in accordance with methods set out in this rule.1

  2. (2)

    Where (1) applies but a firm does not meet the conditions for using the methods set out in BIPRU 4 for all or part of the underlying exposures of the CIU,1risk weighted exposure amounts and expected loss amounts must be calculated in accordance with the following approaches.

  3. (3)

    For equity exposures the approach set out in BIPRU 4.7.9 R - BIPRU 4.7.12 R (Simple risk weights) must be used. If, for those purposes, the firm is unable to differentiate between private equity, exchange-traded and other equity exposures, it must treat the exposures concerned as other equity exposures.

  4. (4)

    For all other underlying exposures, the standardised approach must be used, subject to the following modifications:

    1. (a)

      [deleted]1

      1
    2. (b)

      [deleted]1

      1
    3. (c)

      for exposures subject to a specific risk weight for unrated exposures or subject to the credit quality step yielding the highest risk weight for a given exposure class, the risk weight must be multiplied by a factor of two, but cannot be higher than 1250%; and1

    4. (d)

      for all other exposures, the risk weight must be multiplied by a factor of 1.1 and subject to a minimum of 5%.1

[Note: BCD Article 87(11)]

BIPRU 4.9.12 R
  1. (1)

    Where exposures in the form of a CIU do not meet the criteria set out in BIPRU 3.4.121 R to BIPRU 3.4.122 R (Conditions for look through treatment under the standardised approach) or the firm is not aware of all of the underlying exposures of the CIU, a firm must look through to the underlying exposures and calculate risk weighted exposure amounts and expected loss amounts in accordance with the approach set out in BIPRU 4.7.9 R - BIPRU 4.7.12 R (Simple risk weights). If, for those purposes, the firm is unable to differentiate between private equity, exchange-traded and other equity exposures, it must treat the exposures concerned as other equity exposures. For these purposes, non-equity exposures must be assigned to one of the classes (private equity, exchange traded equity or other equity) set out in BIPRU 4.7.9 R (Simple risk weight approach) and unknown exposures must be assigned to the other equity class.

  2. (2)

    Alternatively to the method described in (1), a firm may calculate itself or rely on a third party to calculate and report the average risk weighted exposure amounts based on the CIU's underlying exposures and calculated in accordance with the approaches in BIPRU 4.9.11R (3) to BIPRU 4.9.11R (4),1 provided that the correctness of the calculation and the report is adequately ensured.

  3. (3)

    [deleted]1

    1
  4. (4)

    [deleted]1

    1
    1. (a) 1

      [deleted]1

    2. (b)

      [deleted]1

      1

[Note: BCD Article 87(12)]

BIPRU 4.9.13 G

For the purposes of BIPRU 4.9.12 R (1), in the case of non-equity exposures a firm should look at the risk profile of the underlying exposures and map these to an equivalent equity risk weight. For example, if the underlying exposures are exchange-traded, the risk weight of exchange-traded equity exposures will apply. If the underlying exposures are unknown, the risk weight of the other equity class will apply. Only under exceptional circumstances would supervisors expect to see non-equity exposures mapped to the diversified private equity risk weight.

BIPRU 4.9.14 G

For the purposes of BIPRU 4.9.12 R (2), a firm should ensure that any third party relied on for the calculations and report possesses the necessary competence and experience to ensure that the calculations and report are correct.

BIPRU 4.9.15 R

The expected loss amounts for exposures referred to in BIPRU 4.9.11 R - BIPRU 4.9.12 R must be calculated in accordance with the methods set out in BIPRU 4.4.61 R (Calculation of expected loss for sovereigns, institutions and corporates), BIPRU 4.5.12 R - BIPRU 4.5.14 R (Calculation of expected loss for specialised lending), BIPRU 4.6.47 R - BIPRU 4.6.48 R (Calculation of expected loss for retail exposures), BIPRU 4.7.12 R, BIPRU 4.7.17 R and BIPRU 4.7.26 R (Calculation of expected loss for equity exposures) and BIPRU 4.8.30 R (Dilution risk of purchased receivables).

[Note: BCD Article 88(6)]

BIPRU 4.10 The IRB approach: Credit risk mitigation

Application

BIPRU 4.10.1 G

BIPRU 4.10 applies to all exposures treated under the IRB approach.

Purpose

BIPRU 4.10.2 G

BIPRU 4.10 sets out modifications to BIPRU 5 (Credit risk mitigation) for those exposures for which the IRB approach is being used.

General

BIPRU 4.10.3 R

A firm using the IRB approach, but not using its own estimates of LGD and conversion factors, may recognise credit risk mitigation in accordance with BIPRU 5 as modified by BIPRU 4.10 in the calculation of risk weighted exposure amounts for the purposes of the calculation of the credit risk capital component or as relevant expected loss amounts for the purposes of the calculation in GENPRU 2.2.191 R to GENPRU 2.2.193 R or GENPRU 2.2.236 R.

[Note: BCD Article 91 (as it applies to the IRB approach)]

BIPRU 4.10.4 R
  1. (1)

    Where the requirements of BIPRU 5.2.2 R - BIPRU 5.2.8 R are met the calculation of risk weighted exposure amounts, and, as relevant, expected loss amounts, may be modified in accordance with BIPRU 5 as modified by BIPRU 4.10.

  2. (2)

    No exposure in respect of which credit risk mitigation is obtained must produce a higher risk weighted exposure amount or expected loss amount than an otherwise identical exposure in respect of which there is no credit risk mitigation.

  3. (3)

    Where the risk weighted exposure amount already takes account of credit protection under the IRB approach the calculation of the credit protection must not be further recognised under BIPRU 5 or BIPRU 4.10.

  4. (4)

    Subject to BIPRU 5.2.8 R (Maturity mismatches), BIPRU 5.2.9 R (Combinations of credit risk mitigation in the standardised approach) and BIPRU 5.7.27 R to BIPRU 5.7.28 R (Basket credit risk mitigation techniques), where the CRM eligibility conditions and the CRM minimum requirements are satisfied, the calculation of risk weighted exposure amounts and expected loss amounts under the IRB approach may be modified in accordance with the provisions of BIPRU 5 and BIPRU 4.10 that deal with calculating the effects of credit risk mitigation.

[Note: BCD Article 93 and Annex VIII Part 3 point 1(as they apply to the IRB approach)]

Eligibility of funded credit protection: General

BIPRU 4.10.5 R

In addition to the collateral set out in BIPRU 5.3.1 R to BIPRU 5.3.2 R, BIPRU 5.4.1 R to BIPRU 5.4.8 R and BIPRU 5.6.1 R (Eligibility of funded credit protection) the provisions of BIPRU 4.10.6 R - BIPRU 4.10.12 R (Eligibility of real estate collateral), BIPRU 4.10.14 R (Eligibility: receivables), BIPRU 4.10.16 R (Eligibility: other physical collateral), and BIPRU 4.10.19 R (Eligibility: leasing), apply where a firm calculates risk weighted exposure amounts and expected loss amounts under the IRB approach.

[Note: BCD Annex VIII Part 1 point 12]

Real estate collateral: Types of eligible collateral: General

BIPRU 4.10.6 R
  1. (1)

    Residential real estate property which is or will be occupied or let by the owner or the beneficial owner in the case of personal investment companies and commercial real estate property, that is offices and other commercial premises, may be recognised as eligible collateral where the conditions set out in the remaining provisions of this paragraph are met.

  2. (2)

    The value of the property must not materially depend upon the credit quality of the obligor. This requirement does not preclude situations where purely macro-economic factors affect both the value of the property and the performance of the borrower.

  3. (3)

    The risk of the borrower must not materially depend 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 must not materially depend on any cash flow generated by the underlying property serving as collateral.

[Note: BCD Annex VIII Part 1 point 13]

BIPRU 4.10.7 R

The condition in BIPRU 4.10.6 R (3) does not apply to exposures secured by residential real estate property situated within the United Kingdom.

[Note: BCD Annex VIII Part 1 point 16 (part)]

BIPRU 4.10.8 G
  1. (1)

    Under paragraph 16 of Part 1 of Annex VIII of the Banking Consolidation Directive, a competent authority may only disapply the condition in BIPRU 4.10.6 R (3) if the competent authority has evidence that the relevant market is well-developed and long-established with loss-rates which are sufficiently low to justify such action.

  2. (2)

    If the evidence were to change so that the action was no longer justified the appropriate regulator would expect to revoke BIPRU 4.10.7 R.

BIPRU 4.10.9 R
  1. (1)

    The condition in BIPRU 4.10.6 R (3) does not apply for exposures secured by residential real estate property situated within the territory of another EEA State.

  2. (2)

    However (1) only applies if and to the extent that the CRD implementation measures for that EEA State in relation to the IRB approach implement the option set out in paragraph 16 of Part 1 of Annex VIII of the Banking Consolidation Directive (waiver for residential real estate property) with respect to residential real estate property situated within that EEA State. Therefore (1) does not apply if the eligibility to use this treatment under those measures ceases as contemplated under paragraph 18 of Part 1 of Annex VIII of the Banking Consolidation Directive (suspension of alternative treatment).

[Note: BCD Annex VIII Part 1 point 16 (part)]

BIPRU 4.10.10 R
  1. (1)

    The condition in BIPRU 4.10.6 R (3) does not apply for commercial real estate property situated within the territory of another EEA State.

  2. (2)

    However (1) only applies if and to the extent that the CRD implementation measures for that EEA State in relation to the IRB approach implement the option set out in paragraph 17 of Part 1 of Annex VIII of the Banking Consolidation Directive (waiver for commercial real estate property) with respect to commercial real estate property situated within that EEA State. Therefore (1) does not apply if the eligibility to use this treatment under those measures ceases as contemplated under paragraph 18 of Part 1 of Annex VIII of the Banking Consolidation Directive (suspension of alternative treatment).

[Note: BCD Annex VIII Part 1 point 19]

Real estate collateral: Types of eligible collateral: Finnish housing legislation

BIPRU 4.10.11 R

A firm may also recognise as eligible collateral shares in Finnish residential housing companies operating in accordance with the Finnish Housing Company Act of 1991 or subsequent equivalent legislation in respect of residential property which is or will be occupied or let by the owner, as residential real estate collateral, provided that the conditions in BIPRU 4.10.6 R are met.

[Note: BCD Annex VIII Part 1 point 14]

BIPRU 4.10.12 R

A firm may also recognise as eligible collateral shares in Finnish housing companies operating in accordance with the Finnish Housing Company Act of 1991 or subsequent equivalent legislation as commercial real estate collateral, provided that the conditions in BIPRU 4.10.6 R are met.

[Note: BCD Annex VIII Part 1 point 15]

Real estate collateral: Minimum requirements for recognition

BIPRU 4.10.13 R

For the recognition of real estate collateral: the minimum requirements in BIPRU 3.4.64 R - BIPRU 3.4.73 R must be met with the following adjustments:

  1. (1)

    those provisions apply to all real estate collateral eligible under BIPRU 4.10; and

  2. (2)

    the minimum frequency of valuation as referred to in BIPRU 3.4.66 R is once every year for commercial real estate.

[Note: BCD Annex VIII Part 2 point 8 (as it applies to the IRB approach)]

Receivables: Types of eligible collateral

BIPRU 4.10.14 R

Amounts receivable linked to a commercial transaction or transactions with an original maturity of less than or equal to one year may be recognised as eligible collateral. Eligible receivables do not include those associated with securitisations, sub-participations or credit derivatives or amounts owed by affiliated parties.

[Note: BCD Annex VIII Part 1 point 20]

Receivables: Minimum requirements for recognition

BIPRU 4.10.15 R
  1. (1)

    For the recognition of receivables as collateral the requirements in this paragraph must be met.

  2. (2)

    The legal mechanism by which the collateral is provided must be robust and effective and ensure that the lender has clear rights over the proceeds.

  3. (3)

    A firm must take all steps necessary to fulfil local requirements in respect of the enforceability of security interests. There must be a framework which allows the lender to have a first priority claim over the collateral subject to any claims of preferential creditors provided for in applicable insolvency law.

  4. (4)

    A firm must have conducted sufficient legal review confirming the enforceability of the collateral arrangements in all relevant jurisdictions.

  5. (5)

    The collateral arrangements must be properly documented, with a clear and robust procedure for the timely collection of collateral. A firm's procedures must ensure that any legal conditions required for declaring the default of the borrower and timely collection of collateral are observed. In the event of the obligor's financial distress or default, a firm must have legal authority to sell or assign the receivables to other parties without consent of the receivables obligors.

  6. (6)

    A firm must have a sound process for determining the credit risk associated with the receivables. Such a process must include, among other things, analyses of the obligor's business and industry and the types of customers with whom the obligor does business. Where a firm relies on the obligor to ascertain the credit risk of the customers, the firm must review the obligor's credit practices to ascertain their soundness and credibility.

  7. (7)

    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 obligor, and potential concentration risk within the firm's total exposures beyond that controlled by the firm's general methodology. A firm must maintain a continuous monitoring process appropriate to the receivables. Additionally, compliance with loan covenants, Environmental restrictions, and other legal requirements must be reviewed on a regular basis.

  8. (8)

    The receivables pledged by an obligor must be diversified and not be unduly correlated with the obligor. Where there is material positive correlation, the attendant risks must be taken into account in the setting of margins for the collateral pool as a whole.

  9. (9)

    Receivables from affiliates of the obligor (including subsidiary undertakings and employees) must not be recognised as risk mitigants.

  10. (10)

    A firm must have a documented process for collecting receivable payments in distressed situations. The requisite facilities for collection must be in place, even when the firm normally looks to the obligor for collections.

[Note: BCD Annex VIII Part 2 point 9]

Other physical collateral: Types of eligible collateral

BIPRU 4.10.16 R

A firm may recognise as eligible collateral a physical item of a type other than those types indicated in BIPRU 4.10.6 R - BIPRU 4.10.12 R (Eligibility of real estate collateral) if its IRB permission provides that the firm may treat collateral of that type as eligible and if the firm is able to demonstrate the following:

  1. (1)

    the existence of liquid markets for disposal of the collateral in an expeditious and economically efficient manner;

  2. (2)

    the existence of well-established, publicly available market prices for the collateral; and

  3. (3)

    there is no evidence that the net prices it receives when collateral is realised deviates significantly from the market prices referred to in (b).

[Note: BCD Annex VIII Part 1 point 21]

BIPRU 4.10.17 G

If a firm wishes to recognise other types of collateral in accordance with BIPRU 4.10.16 R (whether as part of its application for an IRB permission or under a variation of its IRB permission) it should demonstrate to the appropriate regulator how the criteria in BIPRU 4.10.16 R (1) - BIPRU 4.10.16 R (3) have been met with respect to that type of collateral.

Other physical collateral: Minimum requirements for recognition

BIPRU 4.10.18 R
  1. (1)

    If a type of other physical collateral referred to in BIPRU 4.10.16 R is potentially eligible under a firm'sIRB permission a firm must only recognise it as eligible if the minimum requirements in (2) to (10) are met.

  2. (2)

    The collateral arrangement must be legally effective and enforceable in all relevant jurisdictions and must enable the firm to realise the value of the property within a reasonable timeframe.

  3. (3)

    With the sole exception of permissible prior claims referred to in BIPRU 4.10.15 R (3), only first liens on, or charges over, collateral must be permissible. As such, the firm must have priority over all other lenders to the realised proceeds of the collateral.

  4. (4)

    The value of the property must be monitored on a frequent basis and at a minimum once every year. More frequent monitoring must be carried out where the market is subject to significant changes in conditions.

  5. (5)

    The loan agreement (or other agreement documenting the exposure) must include detailed descriptions of the collateral plus detailed specifications of the manner and frequency of revaluation.

  6. (6)

    The types of physical collateral accepted by the firm 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 available for examination.

  7. (7)

    The firm's 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 or a proxy of the volatility of the value of the collateral.

  8. (8)

    Both initial valuation and revaluation must take fully into account any deterioration or obsolescence of the collateral. Particular attention must be paid in valuation and revaluation to the effects of the passage of time on fashion- or date-sensitive collateral.

  9. (9)

    The firm must have the right to inspect the property physically. It must have policies and procedures addressing its exercise of the right to physical inspection.

  10. (10)

    The firm must have procedures to monitor that the property taken as protection is adequately insured against damage.

[Note: BCD Annex VIII Part 2 point 10]

Leasing: Types of eligible transactions and conditions of eligibility

BIPRU 4.10.19 R
  1. (1)

    Where the requirements set out in this paragraph are met, exposures arising from transactions whereby a firm leases property to a third party must be treated the same as loans collateralised by the type of property leased.

  2. (2)

    For the exposures arising from leasing transactions to be treated as collateralised by the type of property leased, the following conditions must be met:

    1. (a)

      the conditions set out or referred to in BIPRU 4.10.13 R or BIPRU 4.10.18 R as appropriate for the recognition as collateral of the type of property leased are met;

    2. (b)

      there is robust risk management on the part of the lessor with respect to the use to which the leased asset is put, its age, and planned duration of its use, including appropriate monitoring of the value of the security;

    3. (c)

      there is in place 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

    4. (d)

      where this has not already been ascertained in calculating the LGD level, the difference between value of the unamortised amount and the market value of the security must not be so large as to overstate the credit risk mitigation attributed to the leased assets.

[Note: BCD Annex VIII Part 1 point 22 and Part 2 point 11]

Calculating risk-weighted exposure amounts and expected loss amounts for funded credit risk mitigation: Introduction

BIPRU 4.10.20 R

BIPRU 4.10.21 R - BIPRU 4.10.37 R and BIPRU 4.10.49 R set out how the calculation of risk weighted exposure amounts and expected loss amounts under BIPRU 4.1 - BIPRU 4.9 may be modified to take into account credit risk mitigation that meets the CRM eligibility conditions and the CRM minimum requirements.

Calculating risk weighted exposure amounts and expected loss amounts for funded credit risk mitigation: Valuation: Receivables

BIPRU 4.10.21 R

The value of receivables for the purpose of calculating the effect of credit risk mitigation must be the amount receivable.

[Note: BCD Annex VIII Part 3 point 66]

Calculating risk weighted exposure amounts and expected loss amounts for funded credit risk mitigation: Valuation: Other physical collateral

BIPRU 4.10.22 R

Physical collateral recognised as eligible as described in BIPRU 4.10.16 R must be valued for the purpose of calculating the effect of credit risk mitigation at its market value. Market value is the estimated amount for which the property would exchange on the date of valuation between a willing buyer and a willing seller in an arm's-length transaction.

[Note: BCD Annex VIII Part 3 point 67]

Calculating risk weighted exposure amounts and expected loss amounts: General treatment

BIPRU 4.10.23 R

BIPRU 4.10.24 R - BIPRU 4.10.29 R apply to collateral in the form of real estate collateral, receivables, other physical collateral and leasing permitted by BIPRU 4.10 and exposures secured by such collateral.

BIPRU 4.10.24 R

LGD* (the effective loss given default) calculated as set out in BIPRU 4.10.25 R - BIPRU 4.10.28 R must be taken as the LGD.

[Note: BCD Annex VIII Part 3 point 68]

BIPRU 4.10.25 R

Where the ratio of the value of the collateral (C) to the exposure value (E) is below a threshold level of C* (the required minimum collateralisation level for the exposure) as laid down in BIPRU 4.10.28 R, LGD* must be the LGD laid down in the other sections of BIPRU 4 for uncollateralised exposures to the counterparty. For this purpose, the exposure value of items listed in BIPRU 4.4.37 R to BIPRU 4.4.39 R and BIPRU 4.8.29 R must be calculated using a conversion factor or percentage of 100% rather than the conversion factors or percentages indicated in those rules.3

[Note: BCD Annex VIII Part 3 point 69]

BIPRU 4.10.26 R

Where the ratio of the value of the collateral to the exposure value exceeds a second, higher threshold level of C** (i.e. the required level of collateralisation to receive full LGD recognition) as laid down in BIPRU 4.10.28 R, LGD* must be that prescribed in that table.

[Note: BCD Annex VIII Part 3 point 70]

BIPRU 4.10.27 R

Where the required level of collateralisation C** is not achieved in respect of the exposure as a whole, the exposure must be considered to be two exposures - that part in respect of which the required level of collateralisation C** is achieved and the remainder.

[Note: BCD Annex VIII Part 3 point 71]

BIPRU 4.10.28 R

Table: Minimum LGD for secured portion of exposures

This table belongs to BIPRU 4.10.24 R - BIPRU 4.10.27 R

LGD* for senior claims or contingent claims

LGD* for subordinated claims or contingent claims

Required minimum collateralisation level of the exposure (C*)

Required minimum collateralisation level of the exposure (C**)

Receivables

35%

65%

0%

125%

Residential real estate/commercial real estate

35%

65%

30%

140%

Other collateral

40%

70%

30%

140%

[Note: BCD Annex VIII Part 3 point 72 (part)]

Calculating risk weighted exposure amounts and expected loss amounts for funded credit risk mitigation: Alternative treatment for real estate collateral

BIPRU 4.10.29 R
  1. (1)

    A firm may apply the treatment in paragraph 74 of Part 3 of Annex VIII of the Banking Consolidation Directive (50% risk weight for exposures secured by real estate) in respect of exposures collateralised by:

    1. (a)

      residential real estate property; or

    2. (b)

      commercial real estate property;

    located in the territory of another EEA State.

  2. (2)

    However (1)(a) or (1)(b) only applies if the CRD implementing measures for that EEA State with respect to the IRB approach have implemented the option set out in the provision of the Banking Consolidation Directive referred to in (1) with respect to the relevant category of real estate property situated within that EEA State.

  3. (3)

    The use of the treatment in (1) with respect to property in another EEA State must be subject to the same conditions as apply under the relevant CRD implementation measures for that EEA State.

[Note: BCD Annex VIII Part 3 point 75]

Calculating risk weighted exposure amounts and expected loss amounts: Mixed pools of collateral

BIPRU 4.10.30 R
  1. (1)

    Where:

    1. (a)

      risk weighted exposure amounts and expected loss amounts are calculated under the IRB approach; and

    2. (b)

      an exposure is collateralised by both financial collateral and other eligible collateral;

    LGD* to be taken as the LGD for the purposes of the IRB approach must be calculated in accordance with this rule.

  2. (2)

    A firm must subdivide the volatility-adjusted value of the exposure (i.e. the value after the application of the volatility adjustment as set out in BIPRU 5.4.28 R (Volatility adjustments under the financial collateral comprehensive method) into parts each covered by only one type of collateral. That is, the firm must divide the exposure into the part covered by eligible financial collateral, the part covered by receivables, the parts covered by commercial real estate property collateral and/or residential real estate property collateral, the part covered by other eligible collateral, and the unsecured part, as relevant.

  3. (3)

    LGD* for each part of exposure must be calculated separately in accordance with the relevant provisions of BIPRU 5 (Credit risk mitigation) and BIPRU 4.10.

[Note: BCD Annex VIII Part 3 points 76 to 78]

Calculating risk weighted exposure amounts and expected loss amounts for funded credit risk mitigation: Other modifications of the rules on credit risk mitigation: Financial collateral simple method

BIPRU 4.10.31 R

The financial collateral simple method must not be used under the IRB approach.

[Note: BCD Annex VIII Part 3 point 24 (part)]

Calculating risk weighted exposure amounts and expected loss amounts for funded credit risk mitigation: Other modifications of the rules on credit risk mitigation: Master netting agreements

BIPRU 4.10.32 R
  1. (1)

    This rule sets out how the calculations under BIPRU 5.6.11 R (Using the supervisory volatility adjustments or the own estimates volatility adjustments approaches to master netting agreements covering repurchase transactions and/or securities or commodities lending or borrowing transactions and/or other capital market driven transactions) must be modified under the IRB approach.

  2. (2)

    Where risk weighted exposure amounts and expected loss amounts are calculated under the IRB approach, E is the exposure value for each separate exposure under the agreement referred to in the provisions listed in (1) that would apply in the absence of the credit protection.

[Note: BCD Annex VIII Part 3 point 11 (as it applies to the IRB approach)]

BIPRU 4.10.33 R
  1. (1)

    This rule sets out how the calculations under BIPRU 5.6.24 R (Using the internal models approach to master netting agreements covering repurchase transactions and/or securities or commodities lending or borrowing transactions and/or other capital market driven transactions) must be modified under the IRB approach.

  2. (2)

    Where risk weighted exposure amounts and expected loss amounts are calculated under the IRB approach E is the exposure value for each separate exposure under the agreement referred to in the provisions listed in (1) that would apply in the absence of the credit protection.

[Note: BCD Annex VIII Part 3 point 20 (as it applies to the IRB approach)]

BIPRU 4.10.34 R
  1. (1)

    This rule sets out how the calculations under BIPRU 5.6.29 R (Calculating risk-weighted exposure amounts and expected loss amounts for master netting agreements covering repurchase transactions and/or securities or commodities lending or borrowing transactions and/or other capital market driven transactions) must be modified under the IRB approach.

  2. (2)

    E* must be taken as the exposure value of the exposure to the counterparty arising from the transactions subject to the master netting agreement referred to in the provisions listed in (1) for the purposes of BIPRU 4.

[Note: BCD Annex VIII Part 3 point 23 (as it applies to the IRB approach)]

Calculating risk weighted exposure amounts and expected loss amounts for funded credit risk mitigation: Other modifications of the rules on credit risk mitigation: Financial collateral comprehensive method

BIPRU 4.10.35 R
  1. (1)

    This rule sets out how the calculations under BIPRU 5.4.28 R (Calculating adjusted values under the financial collateral comprehensive method) must be modified under the IRB approach.

  2. (2)

    E as referred to in the provisions listed in (1) is the exposure value as would be determined under the IRB approach if the exposure was not collateralised. For this purpose, where a firm calculates risk weighted exposure amounts under the IRB approach, the exposure value of the items listed in BIPRU 4.4.37 R to BIPRU 4.4.39 R, BIPRU 4.4.45 R, BIPRU 4.6.44 R (3) and BIPRU 4.8.29 R must be calculated using a conversion factor of 100% rather than the conversion factors or percentages indicated in those provisions.

BIPRU 4.10.36 R
  1. (1)

    This rule sets out the calculation of risk weighted exposure amounts2 and expected loss2 amounts under the financial collateral comprehensive method2 for a firm using the IRB approach.

    222
  2. (2)

    LGD* (the effective loss given default) calculated as set out in this paragraph must be taken as the LGD for the purposes of BIPRU 4.

  3. (3)

    LGD* = LGD x (E*/E) where:

    1. (a)

      LGD is the loss given default that would apply to the exposure under the IRB approach if the exposure was not collateralised;

    2. (b)

      E is the exposure value as calculated under BIPRU 41; and

    3. (c)

      E* is as calculated under BIPRU 5.4.28 R (3)1 (Calculation of adjusted values under the financial collateral comprehensive method).

[Note: BCD Annex VIII Part 3 point 61]

BIPRU 4.10.37 R
  1. (1)

    In the case of a firm using the IRB approach to calculate risk weighted exposure amounts and expected loss amounts, the persons in (2) are added to the list in BIPRU 5.4.64 R (Definition of core market participant).

  2. (2)

    The persons referred to in (1) are other financial companies (including insurance companies) exposures to which do not have a credit assessment by an eligible ECAI and are internally rated as having a probability of default equivalent to that associated with the credit assessments of ECAIs that are associated with credit quality step 2 or above under the rules for the risk weighting of exposures under the standardised approach to credit risk.

[Note: BCD Annex VIII Part 3 point 58(h) (as it applies to the IRB approach)]

Unfunded credit protection: Eligibility of providers

BIPRU 4.10.38 R
  1. (1)

    In the case of a firm using the IRB approach in calculating risk weighted exposure amounts and expected loss amounts, the persons in (2) are added to the list in BIPRU 5.7.1 R (List of eligible providers of unfunded credit protection).

  2. (2)

    The persons referred to in (1) are other corporate entities, including parent undertakings, subsidiary undertakings and affiliate corporate entities of the firm, that do not have a credit assessment by an eligible ECAI and are internally rated as having a probability of default equivalent to that associated with the credit assessments of ECAIs that are associated with credit quality step 2 or above under the rules for the risk weighting of exposures under the standardised approach to credit risk.

[Note: BCD Annex VIII Part 1 point 26(g)(ii)]

BIPRU 4.10.39 R

Where risk weighted exposure amounts and expected loss amounts are calculated under the IRB approach, to be eligible a guarantor must be internally rated by a firm in accordance with the provisions of the minimum IRB standards.

[Note: BCD Annex VIII Part 1 point 27]

Unfunded credit protection: Minimum requirements for assessing the effect of guarantees and credit derivatives: Introduction

BIPRU 4.10.40 R

BIPRU 4.10.41 R to BIPRU 4.10.48 R set out the minimum requirements:

  1. (1)

    assessing the effect of guarantees and credit derivatives for:

    1. (a)

      exposures in the sovereign, institution and corporate IRB exposure class2 where the advanced IRB approach is being used to calculate LGDs; and

    2. (b)

      retail exposures; and

  2. (2)

    additionally, in the case of retail exposure guarantees, to the assignment of exposures to grades or pools, and the estimation of PD.

[Note: BCD Annex VII Part 4 point 97]

BIPRU 4.10.41 R

The requirements in BIPRU 4.10.40 R (2) and BIPRU 4.10.42 R - BIPRU 4.10.48 R do not apply to3 guarantees provided by institutions, central governments, central banks and other corporate entities which meet the requirements in BIPRU 5.7.1 R (7)31 if the firm has received approval under BIPRU 4.2 to apply the standardised approach for exposures to such entities. In this case the requirements of BIPRU 5 (credit risk mitigation) apply.

[Note: BCD Annex VII Part 4 point 96]

3 3

Unfunded credit protection: Minimum requirements for assessing the effect of guarantees and credit derivatives: Eligible guarantors and guarantees

BIPRU 4.10.42 R

A firm must have clearly specified criteria for the types of guarantors it recognises for the calculation of risk weighted exposure amounts.

[Note: Annex VII Part 4 point 98]

BIPRU 4.10.43 R

For recognised guarantors the same requirements as for obligors as set out in BIPRU 4.3.43 R - BIPRU 4.3.48 R (Assignment to grades and pools), BIPRU 4.4.11 R - BIPRU 4.4.18 R and BIPRU 4.4.51 R (Assignment of exposures and rating systems), BIPRU 4.5.6 R (Assignment of exposures) and BIPRU 4.6.11 R and BIPRU 4.6.14 R (Assignment of exposures and rating systems) apply.

[Note: BCD Annex VII Part 4 point 99]

BIPRU 4.10.44 R

The guarantee must be evidenced in writing, non-cancellable on the part of the guarantor, in force until the obligation is satisfied in full (to the extent of the amount and tenor of the guarantee) and legally enforceable against the guarantor in a jurisdiction where the guarantor has assets to attach and enforce a judgement. Guarantees prescribing conditions under which the guarantor may not be obliged to perform (conditional guarantees) may be recognised if the IRB permission permits this. A firm must (in the case of a firm with an IRB permission that permits conditional guarantees) be able to demonstrate to the appropriate regulator that the assignment criteria adequately address any potential reduction in the risk mitigation effect.

[Note: BCD Annex VII Part 4 point 100]

Unfunded credit protection: Minimum requirements for assessing the effect of guarantees and credit derivatives: Adjustment criteria

BIPRU 4.10.45 R

A firm must have clearly specified criteria for adjusting grades, pools or LGD estimates, and in the case of retail exposures and eligible purchased receivables, the process of allocating exposures to grades or pools, to reflect the impact of guarantees for the calculation of risk weighted exposure amounts. These criteria must comply with the minimum requirements referred to in BIPRU 4.10.43 R.

[Note: BCD Annex VII Part 4 point 101]

BIPRU 4.10.46 R

The criteria in BIPRU 4.10.45 R must be plausible and intuitive. They must address the guarantor's ability and willingness to perform under the guarantee, the likely timing of any payments from the guarantor, the degree to which the guarantor's ability to perform under the guarantee is correlated with the obligor's ability to repay, and the extent to which residual risk to the obligor remains.

[Note: BCD Annex VII Part 4 point 102]

Unfunded credit protection: Minimum requirements for assessing the effect of guarantees and credit derivatives: Credit derivatives

BIPRU 4.10.47 R

The minimum requirements for guarantees set out in BIPRU 4.10 also apply for single name credit derivatives. In relation to a mismatch between the underlying obligation and the reference obligation of the credit derivative or the obligation used for determining whether a credit event has occurred the requirements set out under BIPRU 5.7.14 R (Mismatches and credit derivatives) apply. For retail exposures and eligible purchased receivables, this paragraph applies to the process of allocating exposures to grades or pools.

[Note: BCD Annex VII Part 4 point 103]

BIPRU 4.10.48 R

The criteria applied by BIPRU 4.10.47 R must address the payout structure of the credit derivative and conservatively assess the impact this has on the level and timing of recoveries. A firm must consider the extent to which other forms of residual risk remain.

[Note: BCD Annex VII Part 4 point 104]

Unfunded credit protection: Minimum requirements for assessing the effect of guarantees and credit derivatives: Calculating risk weighted exposure amounts and expected loss amounts

BIPRU 4.10.49 R
  1. (1)

    This rule relates to the calculation of risk-weighted exposure amounts and expected loss amounts in the case of unfunded credit protection.

  2. (2)

    BIPRU 5.7.21 R (Tranching) applies for the purpose in (1).

  3. (3)

    The provisions in (4) replace those in BIPRU 5.7.22 R to BIPRU 5.7.25 R (Calculating risk weighted exposure amounts under the standardised approach in the case of unfunded credit protection).

  4. (4)

    For the covered portion of the exposure value E3 (based on the adjusted value of the credit protection GA), the PD for the purposes of BIPRU 4 may be the PD of the protection provider, or a PD between that of the borrower and that of the guarantor if a full substitution is deemed not to be warranted. In the case of subordinated exposures and non-subordinated unfunded protection, the LGD to be applied for the purposes of BIPRU 4 may be that associated with senior claims.

  5. (5)

    For any uncovered portion of the exposure value E3 the PD must be that of the borrower and the LGD must be that of the underlying exposure.

  6. (6)

    GA is the value of G* as calculated under BIPRU 5.7.17 R (Valuation of unfunded credit protection) further adjusted for any maturity mismatch as laid down in BIPRU 4.10.51 R (Maturity mismatches).

  7. (7)

    E is the exposure value as related to the following rules: BIPRU 4.4.38 R, BIPRU 4.4.39 R, BIPRU 4.4.71 R to BIPRU 4.4.78 R, BIPRU 4.7.7 R, BIPRU 4.8.28 R, BIPRU 4.8.29 R and BIPRU 4.9.9 R. For this purpose, the exposure value of the items referred to in BIPRU 4.4.37 R to BIPRU 4.4.39 R and BIPRU 4.8.29 R must be calculated using a conversion factor or percentage of 100% rather than the conversion factors or percentages indicated in those rules.3

[Note: BCD Annex VIII Part 3 points 90 to 92]

Maturity mismatches

BIPRU 4.10.50 R

In addition to BIPRU 5.8.2 R, where there is a maturity mismatch the credit protection must not be recognised where the exposure is a short term exposure specified in the firm'sIRB permission as being subject to a one-day floor rather than a one-year floor in respect of the maturity value (M) under BIPRU 4.4.68 R.

[Note: BCD Annex VIII Part 4 point 2(b)]

BIPRU 4.10.51 R

GA as calculated under BIPRU 5.8.11 R is then taken as the value of the protection for the purposes of calculating the effects of unfunded credit protection under the IRB approach.

[Note: BCD Annex VIII Part 4 point 8 (part)]

BIPRU 4 Annex 1 Supervisory Slotting Criteria for Specialised Lending

This Annex outlines the criteria that must be used to slot a specialised lending exposure into the categories in BIPRU 4.5.6 R.

This table belongs to BIPRU 4.5.6 R and must be used in accordance with that rule only for project finance exposures.

Table 1 - Supervisory Rating Grades for Project Finance Exposures

Strong

Good

Satisfactory

Weak

Financial strength

Market conditions

Few competing suppliers or substantial and durable advantage in location, cost, or technology. Demand is strong and growing

Few competing suppliers or better than average location, cost, or technology but this situation may not last. Demand is strong and stable

Project has no advantage in location, cost, or technology. Demand is adequate and stable

Project has worse than average location, cost, or technology. Demand is weak and declining

Financial ratios (e.g. debt service coverage ratio (DSCR), loan life coverage ratio (LLCR), project life coverage ratio (PLCR), and debt-to-equity ratio)

Strong financial ratios considering the level of project risk; very robust economic assumptions

Strong to acceptable financial ratios considering the level of project risk; robust project economic assumptions

Standard financial ratios considering the level of project risk

Aggressive financial ratios considering the level of project risk

Stress analysis

The project can meet its financial obligations under sustained, severely stressed economic or sectoral conditions

The project can meet its financial obligations under normal stressed economic or sectoral conditions. The project is only likely to default under severe economic conditions

The project is vulnerable to stresses that are not uncommon through an economic cycle, and may default in a normal downturn

The project is likely to default unless conditions improve soon

Financial structure

Duration of the credit compared to the duration of the project

Useful life of the project significantly exceeds tenor of the loan

Useful life of the project exceeds tenor of the loan

Useful life of the project exceeds tenor of the loan

Useful life of the project may not exceed tenor of the loan

Amortisation schedule

Amortising debt

Amortising debt

Amortising debt repayments with limited bullet payment

Bullet repayment or amortising debt repayments with high bullet repayment

Political and legal environment

Political risk, including transfer risk, considering project type and mitigants

Very low exposure; strong mitigation instruments, if needed

Low exposure; satisfactory mitigation instruments, if needed

Moderate exposure; fair mitigation instruments

High exposure; no or weak mitigation instruments

Force majeure risk (war, civil unrest, etc)

Low exposure

Acceptable exposure

Standard protection

Significant risks, not fully mitigated

Government support and project's importance for the country over the long term

Project of strategic importance for the country (preferably export-oriented). Strong support from Government

Project considered important for the country. Good level of support from Government

Project may not be strategic but brings unquestionable benefits for the country. Support from Government may not be explicit

Project not key to the country. No or weak support from Government

Stability of legal and regulatory environment (risk of change in law)

Favourable and stable regulatory environment over the long term

Favourable and stable regulatory environment over the medium term

Regulatory changes can be predicted with a fair level of certainty

Current or future regulatory issues may affect the project

Acquisition of all necessary supports and approvals for such relief from local content laws

Strong

Satisfactory

Fair

Weak

Enforceability of contracts, collateral and security

Contracts, collateral and security are enforceable

Contracts, collateral and security are enforceable

Contracts, collateral and security are considered enforceable even if certain non-key issues may exist

There are unresolved key issues in respect if actual enforcement of contracts, collateral and security

Transaction characteristics

Design and technology risk

Fully proven technology and design

Fully proven technology and design

Proven technology and design - start-up issues are mitigated by a strong completion package

Unproven technology and design; technology issues exist and/or complex design

Construction risk

Permitting and siting

All permits have been obtained

Some permits are still outstanding but their receipt is considered very likely

Some permits are still outstanding but the permitting process is well defined and they are considered routine

Key permits still need to be obtained and are not considered routine. Significant conditions may be attached

Type of construction contract

Fixed-price date-certain turnkey construction EPC (engineering and procurement contract)

Fixed-price date-certain turnkey construction EPC

Fixed-price date-certain turnkey construction contract with one or several contractors

No or partial fixed-price turnkey contract and/or interfacing issues with multiple contractors

Completion guarantees

Substantial liquidated damages supported by financial substance and/or strong completion guarantee from sponsors with excellent financial standing

Significant liquidated damages supported by financial substance and/or completion guarantee from sponsors with good financial standing

Adequate liquidated damages supported by financial substance and/or completion guarantee from sponsors with good financial standing

Inadequate liquidated damages or not supported by financial substance or weak completion guarantees

Track record and financial strength of contractor in constructing similar projects.

Strong

Good

Satisfactory

Weak

Operating risk

Scope and nature of operations and maintenance (O & M) contracts

Strong long-term O&M contract, preferably with contractual performance incentives, and/or O&M reserve accounts

Long-term O&M contract, and/or O&M reserve accounts

Limited O&M contract or O&M reserve account

No O&M contract: risk of high operational cost overruns beyond mitigants

Operator's expertise, track record, and financial strength

Very strong, or committed technical assistance of the sponsors

Strong

Acceptable

Limited/weak, or local operator dependent on local authorities

Off-take risk

(a) If there is a take-or-pay or fixed-price off-take contract:

Excellent creditworthiness of off-taker; strong termination clauses; tenor of contract comfortably exceeds the maturity of the debt

Good creditworthiness of off-taker; strong termination clauses; tenor of contract exceeds the maturity of the debt

Acceptable financial standing of off-taker; normal termination clauses; tenor of contract generally matches the maturity of the debt

Weak off-taker; weak termination clauses; tenor of contract does not exceed the maturity of the debt

(b) If there is no take-or-pay or fixed-price off-take contract:

Project produces essential services or a commodity sold widely on a world market; output can readily be absorbed at projected prices even at lower than historic market growth rates

Project produces essential services or a commodity sold widely on a regional market that will absorb it at projected prices at historical growth rates

Commodity is sold on a limited market that may absorb it only at lower than projected prices

Project output is demanded by only one or a few buyers or is not generally sold on an organised market

Supply risk

Price, volume and transportation risk of feed-stocks; supplier's track record and financial strength

Long-term supply contract with supplier of excellent financial standing

Long-term supply contract with supplier of good financial standing

Long-term supply contract with supplier of good financial standing - a degree of price risk may remain

Short-term supply contract or long-term supply contract with financially weak supplier - a degree of price risk definitely remains

Reserve risks (e.g. natural resource development)

Independently audited, proven and developed reserves well in excess of requirements over lifetime of the project

Independently audited, proven and developed reserves in excess of requirements over lifetime of the project

Proven reserves can supply the project adequately through the maturity of the debt

Project relies to some extent on potential and undeveloped reserves

Strength of Sponsor

Sponsor's track record, financial strength, and country/sector experience

Strong sponsor with excellent track record and high financial standing

Good sponsor with satisfactory track record and good financial standing

Adequate sponsor with adequate track record and good financial standing

Weak sponsor with no or questionable track record and/or financial weaknesses

Sponsor support, as evidenced by equity, ownership clause and incentive to inject additional cash if necessary

Strong. Project is highly strategic for the sponsor (core business - long-term strategy)

Good. Project is strategic for the sponsor (core business - long-term strategy)

Acceptable. Project is considered important for the sponsor (core business)

Limited. Project is not key to sponsor's long-term strategy or core business

Security Package

Assignment of contracts and accounts

Fully comprehensive

Comprehensive

Acceptable

Weak

Pledge of assets, taking into account quality, value and liquidity of assets

First perfected security interest in all project assets, contracts, permits and accounts necessary to run the project

Perfected security interest in all project assets, contracts, permits and accounts necessary to run the project

Acceptable security interest in all project assets, contracts, permits and accounts necessary to run the project

Little security or collateral for lenders; weak negative pledge clause

Lender's control over cash flow (e.g. cash sweeps, independent escrow accounts)

Strong

Satisfactory

Fair

Weak

Strength of the covenant package (mandatory prepayments, payment deferrals, payment cascade, dividend restrictions...)

Covenant package is strong for this type of project

Project may issue no additional debt

Covenant package is satisfactory for this type of project

Project may issue extremely limited additional debt

Covenant package is fair for this type of project

Project may issue limited additional debt

Covenant package is Insufficient for this type of project

Project may issue unlimited additional debt

Reserve funds (debt service, O&M, renewal and replacement, unforeseen events, etc)

Longer than average coverage period, all reserve funds fully funded in cash or letters of credit from highly rated bank

Average coverage period, all reserve funds fully funded

Average coverage period, all reserve funds fully funded

Shorter than average coverage period, reserve funds funded from operating cash flows

This table belongs to BIPRU 4.5.6 R and must be used in accordance with that rule only for income-producing real estate exposures

Table 2 - Supervisory Rating Grades for Income-Producing Real Estate Exposures

Strong

Good

Satisfactory

Weak

Financial strength

Market conditions

The supply and demand for the project's type and location are currently in equilibrium. The number of competitive properties coming to market is equal or lower than forecasted demand

The supply and demand for the project's type and location are currently in equilibrium. The number of competitive properties coming to market is roughly equal to forecasted demand

Market conditions are roughly in equilibrium. Competitive properties are coming on the market and others are in the planning stages. The project's design and capabilities may not be state of the art compared to new projects

Market conditions are weak. It is uncertain when conditions will improve and return to equilibrium. The project is losing tenants at lease expiration. New lease terms are less favourable compared to those expiring

Financial ratios and advance rate

The property's debt service coverage ratio (DSCR) is considered strong (DSCR is not relevant for the construction phase) and its loan to value ratio (LTV) is considered low given its property type. Where a secondary market exists, the transaction is underwritten to market standards

The DSCR (not relevant for development real estate) and LTV are satisfactory. Where a secondary market exists, the transaction is underwritten to market standards

The property's DSCR has deteriorated and its value has fallen, increasing its LTV

The property's DSCR has deteriorated significantly and its LTV is well above underwriting standards for new loans

Stress analysis

The property's resources, contingencies and liability structure allow it to meet its financial obligations during a period of severe financial stress (e.g. interest rates, economic growth)

The property can meet its financial obligations under a sustained period of financial stress (e.g. interest rates, economic growth). The property is likely to default only under severe economic conditions

During an economic downturn, the property would suffer a decline in revenue that would limit its ability to fund capital expenditures and significantly increase the risk of default

The property's financial condition is strained and is likely to default unless conditions improve in the near term

Cash-flow predictability

(a) For complete and stabilised property

The property's leases are long-term with creditworthy tenants and their maturity dates are scattered. The property has a track record of tenant retention upon lease expiration. Its vacancy rate is low. Expenses (maintenance, insurance, security, and property taxes) are predictable

Most of the property's leases are long-term, with tenants that range in creditworthiness. The property experiences a normal level of tenant turnover upon lease expiration. Its vacancy rate is low. Expenses are predictable

Most of the property's leases are medium rather than long-term with tenants that range in creditworthiness. The property experiences a moderate level of tenant turnover upon lease expiration. Its vacancy rate is moderate. Expenses are relatively predictable but vary in relation to revenue

The property's leases are of various terms with tenants that range in creditworthiness. The property experiences a very high level of tenant turnover upon lease expiration. Its vacancy rate is high. Significant expenses are incurred preparing space for new tenants

(b) For complete but not stabilised property

Leasing activity meets or exceeds projections. The project should achieve stabilisation in the near future

Leasing activity meets or exceeds projections. The project should achieve stabilisation in the near future

Most leasing activity is within projections; however, stabilisation will not occur for some time

Market rents do not meet expectations. Despite achieving target occupancy rate, cash flow coverage is tight due to disappointing revenue

(c) For construction phase

The property is entirely pre-leased through the tenor of the loan or pre-sold to an investment grade tenant or buyer, or the bank has a binding commitment for take-out financing from an investment grade lender

The property is entirely pre-leased or pre-sold to a creditworthy tenant or buyer, or the bank has a binding commitment for permanent financing from a creditworthy lender

Leasing activity is within projections but the building may not be pre-leased and there may not exist a take-out financing. The bank may be the permanent lender

The property is deteriorating due to cost overruns, market deterioration, tenant cancellations or other factors. There may be a dispute with the party providing the permanent financing

Asset characteristics

Location

Property is located in highly desirable location that is convenient to services that tenants desire

Property is located in desirable location that is convenient to services that tenants desire

The property location lacks a competitive advantage

The property's location, configuration, design and maintenance have contributed to the property's difficulties

Design and condition

Property is favoured due to its design, configuration, and maintenance, and is highly competitive with new properties

Property is appropriate in terms of its design, configuration and maintenance. The property's design and capabilities are competitive with new properties

Property is adequate in terms of its configuration, design and maintenance

Weaknesses exist in the property's configuration, design or maintenance

Property is under construction

Construction budget is conservative and technical hazards are limited. Contractors are highly qualified

Construction budget is conservative and technical hazards are limited. Contractors are highly qualified

Construction budget is adequate and contractors are ordinarily qualified

Project is over budget or unrealistic given its technical hazards. Contractors may be under qualified

Strength of Sponsor/Developer

Financial capacity and willingness to support the property

The sponsor/developer made a substantial cash contribution to the construction or purchase of the property. The sponsor/developer has substantial resources and limited direct and contingent liabilities. The sponsor/developer's properties are diversified geographically and by property type

The sponsor/developer made a material cash contribution to the construction or purchase of the property. The sponsor/developer's financial condition allows it to support the property in the event of a cash flow shortfall. The sponsor/developer's properties are located in several geographic regions

The sponsor/developer's contribution may be immaterial or non-cash. The sponsor/developer is average to below average in financial resources

The sponsor/developer lacks capacity or willingness to support the property

Reputation and track record with similar properties

Experienced management and high sponsors' quality. Strong reputation and lengthy and successful record with similar properties

Appropriate management and sponsors' quality. The sponsor or management has a successful record with similar properties

Moderate management and sponsors' quality. Management or sponsor track record does not raise serious concerns

Ineffective management and substandard sponsors' quality. Management and sponsor difficulties have contributed to difficulties in managing properties in the past

Relationships with relevant real estate actors

Strong relationships with leading actors such as leasing agents

Proven relationships with leading actors such as leasing agents

Adequate relationships with leasing agents and other parties providing important real estate services

Poor relationships with leasing agents and/or other parties providing important real estate services

Security Package

Nature of lien

Perfected first lien (Note 1)

Perfected first lien (Note 1)

Perfected first lien (Note 1)

Ability of lender to foreclose is constrained

Assignment of rents (for projects leased to long-term tenants)

The lender has obtained an assignment. They maintain current tenant information that would facilitate providing notice to remit rents directly to the lender, such as a current rent roll and copies of the project's leases

The lender has obtained an assignment. They maintain current tenant information that would facilitate providing notice to the tenants to remit rents directly to the lender, such as current rent roll and copies of the project's leases

The lender has obtained an assignment. They maintain current tenant information that would facilitate providing notice to the tenants to remit rents directly to the lender, such as current rent roll and copies of the project's leases

The lender has not obtained an assignment of the leases or has not maintained the information necessary to readily provide notice to the building's tenants

Quality of the insurance coverage

Appropriate

Appropriate

Appropriate

Substandard

Note 1: Lenders in some markets extensively use loan structures that include junior liens. Junior liens may be indicative of this level of risk if the total LTV inclusive of all senior positions does not exceed a typical first loan LTV.

This table belongs to BIPRU 4.5.6 R and must be used in accordance with that rule only for object finance exposures

Table 3 - Supervisory Rating Grades for Object Finance Exposures

Strong

Good

Satisfactory

Weak

Financial strength

Market conditions

Demand is strong and growing, strong entry barriers, low sensitivity to changes in technology and economic outlook

Demand is strong and stable. Some entry barriers, some sensitivity to changes in technology and economic outlook

Demand is adequate and stable, limited entry barriers, significant sensitivity to changes in technology and economic outlook

Demand is weak and declining, vulnerable to changes in technology and economic outlook, highly uncertain environment

Financial ratios (debt service coverage ratio and loan-to-value ratio)

Strong financial ratios considering the type of asset. Very robust economic assumptions

Strong / acceptable financial ratios considering the type of asset. Robust project economic assumptions

Standard financial ratios for the asset type

Aggressive financial ratios considering the type of asset

Stress analysis

Stable long-term revenues, capable of withstanding severely stressed conditions through an economic cycle

Satisfactory short-term revenues. Loan can withstand some financial advers