DIFFERENT APPROACHES DIFFERENT APPROACHES FOR CREDIT RISK FOR CREDIT RISK CONTROL AND LOAN LOSS CONTROL AND LOAN LOSS PROVISIONINGPROVISIONING

THE SPANISH EXPERIENCETHE SPANISH EXPERIENCE

Javier de la CruzBucharest, April 2007

FINANCIAL FINANCIAL INFORMATION FLOWSINFORMATION FLOWS

FINANCIAL INFORMATION FLOWS

FINANCIALINFORMATION

SHAREHOLDERSSUPERVISORS

FINANCIALMARKETS

COSTUMERSTAX

AUTHORITIES

STATISTICALREQUIREMENTS

INVESTORS

MANAGERS

CRAs

FINANCIALANALYSTS

MEDIA...

BANKINGSUPERVISORS

SECURITIESSUPERVISORS

NATIONAL

REGIONAL.LOCAL...

CENTRAL BANK& NATIONAL

INTERNATIONAL

MISBUDGETS,

MARKETING,...

PUBLICREGISTERS

LEGALINFORM.

CCR

FINANCIAL INFORMATION FLOWS

FINANCIALINFORMATION

SHAREHOLDERSSUPERVISORS

FINANCIALMARKETS

COSTUMERSTAX

AUTHORITIES

STATISTICALREQUIREMENTS

INVESTORS

MANAGERS

CRAs

FINANCIALANALYSTS

MEDIA...

BANKINGSUPERVISORS

SECURITIESSUPERVISORS

NATIONAL

REGIONAL.LOCAL...

CENTRAL BANK& NATIONAL

INTERNATIONAL

MISBUDGETS,

MARKETING,...

PUBLICREGISTERS

LEGALINFORM.

CCR

FINANCIALGROUPS

INTERNATIONALACTIVITIES

CONSOLIDATIONDIFFERENTCOUNTRIES

FINANCIAL FINANCIAL INFORMATION FLOWSINFORMATION FLOWS

There are many information users with different needs, so there must be different and specific information flows, regardless of convergence efforts.

FINANCIAL FINANCIAL INFORMATION INFORMATION GENERATIONGENERATION

FINANCIAL INFORMATION GENERATION

TRADITIONALAPPROACH

ACCOUNTINGFINANCIAL

STATEMENTSFINANCIAL

INFORMATION

TRANSFORMATION

INTERNALSECTOR

PUBLICSECTOR

PRIVATESECTOR

BUSINESSOPERATIONS

FINANCIAL INFORMATION GENERATION

MODERNAPPROACH

INTERNALSECTOR

PUBLICSECTOR

PRIVATESECTOR

BUSINESSOPERATIONS DATABASES APPLICATIONS

PRINCIPLES&

PARAMETERS

FINANCIAL FINANCIAL INFORMATION INFORMATION GENERATIONGENERATION

Information must be stored with a business perspective, IT allows to easily prepare reports in quite different ways, according to what is needed in each case.

CREDIT RISKCREDIT RISK

CREDIT RISK

TRADITIONALAPPROACH

RISK MUST BE REDUCEDOR ELIMINATED

LENDING BASEDON EXPERIENCEAND COLLATERAL

LOAN LOSSES AREA NEGATIVE SURPRISE

RISK IS ANEGATIVE ELEMENT

LOAN LOSS PROVISIONINGIS MADE

CASE BY CASE

SPECIFICPROVISIONS

EX POSTPROVISIONS

CONSERVATIVEAPPROACH

GENERICPROVISIONS

EX ANTEPROVISIONS

HIDDEN RESERVESCLOSE TO CAPITAL

CREDIT RISK

MODERNAPPROACH

RISK MUST BECONTROLLED AND

MANAGED

CREDITS GRANTED ONCREDIT RISKEVALUATION

LOAN LOSSES ARE INCORPORATEDTO INTEREST RATES

PRICING

RISK ISPART OF THE BUSINESS

GENERICPROVISIONS

STATISTICALPROVIONS

SPECIFICPROVISIONS

CAPITALEX ANTE

ESTIMATIONEX POST

ESTIMATION

UNEXPECTEDLOSS

EXPECTEDLOSS

CONFIRMEDLOSS

STATISTICALPROVISIONS

LOAN LOSSPROVISIONING

SPECIFICPROVISIONS

REALLOSS

GENERICPROVISIONS

SOLVENCYUNEXPECTED

LOSSCAPITAL

REQUIREMENTS

INTERNAL MODELSPD & LGD & EL & UL

EL LGD

UL

“ANTICYCLICALPROVISIONS”

CREDIT RISKCREDIT RISK

Credit Risk Control and Management has significantly improved and this must be recognised from all the relevant perspectives.

ACCOUNTING AND ACCOUNTING AND SUPERVISORYSUPERVISORYAPPROACHESAPPROACHES

ACCOUNTING AND SUPERVISORY APPROACHES

ACCOUNTINGAPPROACH

REAL LOSSESLOAN LOSS PROVISIONINGCASE BY CASEESTIMATIONS

PORTFOLIOESTIMATIONS

SUPERVISORYAPPROACH

EXPECTEDLOSSES

LOAN LOSS PROVISIONING PD LGD

INTERNATIONALSTANDARDS

ACCOUNTING

SUPERVISION

IAS

BASEL

FORWARDLOOKING

POLICYEFFECTS

EFFECTIVEINT. RATES

CAPITAL

STANDARDSSETTER?

ACCOUNTING AND ACCOUNTING AND SUPERVISORYSUPERVISORYAPPROACHESAPPROACHES

Accounting and supervisory approaches are evolving and converging on an international basis in a parallel way, although there is still a clear need for mutual understanding, ON AN INTERNATIONAL BASIS AND UNDER MODERN RISK CONTROL AND MANAGEMENT FRAMEWORKS.

TAXATIONTAXATIONAPPROACHAPPROACH

TAXATION APPROACH

TRADITIONALAPPROACH

FINANCIALSTATEMENTS

TAX FORMSTAXES ARE A %

OF PROFITS

HIGHER PROVISIONS= LOWER TAXES

INCENTIVES FORLOWER PROVISIONS

FINANCIAL INFORMATIONIS AN INSTRUMENT,

NOT THE TARGET

FISCALPOLICIES

TAXES = INCENTIVES FORHIGHER PROVISIONS

IMAGE = INCENTIVES FORLOWER PROVISIONS

TAXES = INCENTIVES FORHIGHER PROVISIONS

SOLVENCY = INCENTIVESFOR HIGHER PROVISIONS

BALANCEOF POWER

SUPERVISORYPROVISIONS

PROVISIONCAPS

TAXPROVISIONS

TAXATION APPROACH

MODERNAPPROACH

FINANCIALSTATEMENTS

PROFIT AND LOSS TAXES

FISCALPOLICIES

ADJUSTMENTS TO TAXES,NOT TO PROFITS

TECHNICALCRITERIA

FINANCIALINFORMATION

BALANCEOF POWER

DEFERRED&

ANTICIPATED

TAXES

TAXATIONTAXATIONAPPROACHAPPROACH

Tax issues should no longer directly influence financial information. Taxation should begin where profits and losses are technically determined.

THE SPANISH THE SPANISH EXPERIENCEEXPERIENCE

THE SPANISH EXPERIENCE

EARLY 1980´s

DEFAULTEVENTS

OBJECTIVEEVENTS(TIME)

NON-PERFORMINGLOANS

SUBJECTIVEEVENTS

(FINANCIAL CONDITION)

COLLATERAL& GUARANTEES

ASSETSCLASSES

ELAPSEDTIME

SPECIFIC PROVISIONSAS % OF LOANS

NON-PERFORMINGDEBTORS

TYPE OFLENDING

SHORT AND LONGTABLES

PAST DUE

CRITICALSITUATION

...MINIMUMMATURITY MAXIMUM... ...

TECHNICALDELAY

OBJECTIVEDETERIORATION

DEFAULTED DEBT WRITE-OFF

SIGNIFICANTDELAY

HIGHRECOVERY

DECREASINGRECOVERY

MARGINALRECOVERY

NOPROVISIONS

INCREASING PROVISIONS(FROM 25% TO 100%)

WRITE-OFF

NON-ACCRUAL BASIS???RECOVERIES =EXTR. ITEMS

OBJECTIVE APPROACH

DOUBTFUL

CRITICALSITUATION

...MINIMUMMATURITY MAXIMUM...

EVALUATION OFTIME & FINANCIAL CONDITION

PAST DUE/DOUBTFUL WRITE-OFF

SERIOUS CONCERNABOUT

REGULAR PAYMENT

SIGNIFICANTLOSS

DECREASINGRECOVERY

MARGINALRECOVERY

MINIMUM PROVISIONS(10% - 25%)

INCREASING PROVISIONS(FROM 25% TO 100%)

WRITE-ÓFF

NON-ACCRUAL BASISRECOVERIES =EXTR. ITEMS

SUBJECTIVE APPROACH

THE SPANISH EXPERIENCE

LATE 1990´sSTATISTICALPROVISIONS

CREDIT RISKNTERNAL MODELS

HISTORICALPROJECTIONS

QUALITATIVEASPECTS

LATE 1980´sHIGH PROFITS

CYCLE CONCERNS

EARLY 1980´sSPECIFIC

PROVISIONS

HIDDEN RESERVESFOR EXTREME LOSSES

GENERICPROVISIONS

CREDITRISK

CONTROL

RISKCONTROL

INCENTIVES

MOREACCURATE

EVALUATION

STOCK

FLOW

CONVERGENCE AND CHALLENGES

EARLY 2000´s

BASELBANKING

APPROACH

IAS“PUBLIC” COMPANIES

APPROACH

INTERNATIONALCONVERGENCE

NATIONALSTANDARDS SETTER?

INTERNATIONALCONVERGENCE

CAPITAL

EUROPEANUNION

EUROPEANUNION

BISMEMBER

UNEXPECTEDLOSS

EXPECTEDLOSS

LOAN LOSS PROVISIONINGFOR “PUBLIC” COMPANIES

INTERNALMODELS

GENERIC &SPECIFIC

PROVISIONS

LOAN LOSS PROVISIONING

LOAN LOSSPROVISIONS

GENERICPROVSIONS

SPECIFICPROVSSIONS

“OLD GENERIC”

“OLD STATISTICAL”

SUBSTANDARD

PAST DUE5 CALENDARS

DOUBTFUL

STOCKUL

FLOWEL

INTERNALMODELS

INDIVIDUALANALYSIS

COLLECTIVEANALYSIS

GENERIC PROVISIONS

NORMALRISK

NO SIGNIFICANTRISK

0,0% 0,00%

0,6% 0,15%

LOWRISK

MEDIUM - LOWRISK

MEDIUMRISK

MEDIUM - HIGHRISK

HIGHRISK

1,5% 0,60%

1,8% 0,,90%

2,0% 1,50%

2,5% 2,25%

GENERIC PROVISIONS

GENERICPROVISIONS

“OLD STATISTICAL

“OLD GENERIC”

VOLUMEVARIATION

VOLUME

“OLD GENERIC”

“OLD STATISTICAL

SPECIFIC LOANLOSS PROVSIONING

GENERIC LOANLOSS PROVISIONING

EVERY YEAR,FOR EACH KIND OF RISK

THE SPANISH THE SPANISH EXPERIENCEEXPERIENCE

The Spanish experience shows that priorities have to be set to strike a balance and address the challenges that arise around the credit risk control and management modernisation processes, where international convergence trends from different perspectives still need mutual understanding and further coordination.