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Special Diagnostic Studies 2015 Final results
Bank Supervision Department 18 December 2015
2
Contents:
Scope, timeline and SDS work-blocks
Slide(s)
4-6
Key findings 8-13
Follow-up activities 15
Scope and Timeline of the Exericse
3
The SDS was an exercise of unprecedented nature in Serbian banking sector
4
Entity Coverage • 14 banks1, together representing 88% of the banking system total assets as of 31 March 2015
• Selection based on criteria of systemic relevance, representativeness of the banking sector and risk.
Risk coverage
• Evaluation of credit risk for all instruments measured at amortized cost within the performing (PE),
non-performing (NPE) and forborne (FBN) portfolios
• Foreclosed portfolios were reviewed, where material in line with SDS criteria
Portfolio coverage
• Focus on corporate exposures (legal entities including large exposures, connected clients and bank
related parties) and retail exposures (residential real estate exposures, retail SME and other retail
exposures) in the territory of the Republic of Serbia as of 31 March 2015.
Methodological baseline
• Performed in accordance with generally accepted auditing standards (ISA) and based on IFRS and
NBS prudential regulations.
• Auditors have been obligated to follow the requirements defined in the technical manual (‘SDS
Manual’) that provides the key methodological underpinnings of the exercise, as well as set of FAQs
and additional instructions and clarifying illustrations of NBS
Consultants
• 4 auditor companies (Deloitte, PWC, Ernst & Young and BDO) doing the fieldwork and reviewing the
bank files;
• additional 6 independent external appraisal companies doing the (re)valuations of eligible collaterals
(JLL, CBRE, Colliers, Danos, NAI Atrium and Coreside) under IVS2 benchmark
Breadth of the exercise
• More than 90 individual bank portfolios examined3;
• 1,870 corporate portfolio debtors analyzed in detail (10,700 individual corporate facilities in scope);
• Numerous commercial real estate related (CRE4) collaterals and over 4,200 residential properties
(re)valued or its values reviewed in line with SDS criteria during the course of the SDS
1-Banca Intesa A.D. Belgrade, Komercijalna banka A.D. Belgrade, Unicredit Banka A.D. Belgrade, Raiffeisen Banka A.D. Belgrade, Societe Generale Banka Serbia A.D. Belgrade,
Agroindustrijsko Komercijalna banka AIK Banka A.D., Beograd, Eurobanka A.D. Belgrade, Vojvodjanska banka A.D. Belgrade, Banka Postanska stedionica A.D. Belgrade, Hypo Alpe-
Adria Banka A.D. Belgrade, Sberbanka Serbia A.D. Belgrade, Erste Bank A.D. Novi Sad, Alpha Bank Serbia A.D. Belgrade and Piraeus Bank A.D. Belgrade.
2-International Valuation Standards; 3-portfolios covered in individual and collective provisioning work-blocks; 4-Buildings, Land, Shopping malls, Industrial properties, Warehouses etc.
Timeline of the SDS Four distinct phases …
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Initial preparations
Auditor selection, SDS Manual finalization and SDS approach refinement Fieldwork (work-blocks)
Reporting, conclusions and post-SDS follow up activities
December 2014 – March 2015 April –June 2015 July – Mid October 2015 Mid October – December 2015
• AQR comparative
analysis1
• Finalizing preselection of
eligible consultants
• On-site project
implementation initiated
• Initial preliminary reports
delivered starting from
Late October
• Consultations with IMF
and other stakeholders
• Engaging with the in-
scope banks (initial
meeting)
• 9 work-blocks in total5
1) PP&A
2) LT&DIV
3) Sampling
4) CFR
5) C&REV
6) POF
7) Collective
provisioning
8) SDS adjusted CAR
calculation
9) QA&PT
• Final reports delivered by
end November and
distributed to banks
• Work on conceptual
documents (initial
conceptual proposals)2
• Final consultations and
alignment with IMF and
auditors (including
appraisers) at the point of
making the final SDS
Manual and final SDS
approach
• Engaging with the in-
scope banks (final
meeting) and presentation
of initial aggregate results
• Adjusting the approach
based on ECB AQR and
other relevant experiences
• Concatenation of results,
and aggregate report
finalization
• Launching the consultant
selection process3
• Final versions of TOR and
SDS manual4
• Preliminary individual
meetings with the banks
post SDS
• Contracting between
banks and
auditors/appraisers
1-See ECB 2014 and 2015, Slovenia 2013, Spain 2012, Ireland 2011, Greece 2011, Cyprus 2012 and Portugal 2012. 2-Terms of Reference and SDS Manual; 3-Public selection
process initiated by NBS in order to short list the eligible auditors in line with preselection criteria (ie. capacity, ECB AQR related experience, cost); 4-NBS Executive Board meeting on
15 May 2015; 5-PP&A – Policies, Processes and Accounting Review; LT&DIV – Loan tape and data integrity validation; Sampling; CFR - Credit file review; C&CREV-Collateral and
Real Estate evaluation; POF-Projection of findings, Collective provisioning; SDS adjusted capital calculation; QA&PT – Quality Assurance and Progress Tracking
1 2 3 4
SDS Work-blocks
6
WB 1 ●Processes,
Policies & Accounting Review
WB 2 ● Loan Tape
and Data Integrity Validation
WB 3 ● Sampling
WB 4 ● Credit File
Review
WB 5 ●Collateral and Real Estate Revaluation
WB 6 ● Projection of findings
WB 7 ● Collective Provisioning
Review
WB 8 ● SDS
adjusted CAR and Remediation activities for banks following the SDS
Quality Assurance and Progress Tracking
Key Findings
7
Summary of Key Findings
8
The exercise has not identified any capital shortfalls for 14 banks in scope …
• Net SDS capital impact, when taking into account the offsetting between impairment
reinforcements and banks’ prudential loan-loss reserves, resulted in aggregate decrease of
in-scope banks’ SDS adjusted CAR ratio by 176 bps (decrease from 20.21% CAR ratio to
18.45% SDS adjusted CAR ratio)
Biggest quantitative impact derives from credit file review work-block (CFR) with gross impact of EUR 349 million (net of RREL1 reversal EUR 103 million) …
• CFR identified the need to reinforce existing IFRS provisioning levels by 44%
• Existing gone-concern2 NPEs are the key driver of additional provisions in the amount of
EUR 229 million (EUR 41 million net of RREL reversals);
• 184 corporate debtors (14.1% of existing performing clients) were reclassified to NPE
category, in accordance with SDS criteria, with overall additional provision impact of EUR
80 million (EUR 60 million net of reversals for RREL);
Non-performing exposure (NPE) levels are for the first time benchmarked along the lines of simplified version of comprehensive NPE definition published by European Banking Authority …
• EUR 2,602 million NPEs within the sampled corporate portfolio identified, an increase of
EUR 738 million in comparison to reported initial values under SDS exercise.
• The NBS estimates the effects of SDS on the total NPL ratio of in-scope banks to be
commensurate with 4.7 pp increase (i.e. a 4.7 pp increase in total NPL ratio for the 14
banks participating in SDS – from 22.6% to 27.4%);
• NBS has used the reclassifications to screen the potential level of NPLs by introducing
more strict and forward looking criteria.
Certain number of qualitative issues highlighted in consultants reports in need of additional action by the banks …
• Shortcomings regarding financial analysis of corporate clients and impairment triggers
• Issues with individual and collective provisioning approach,
• Income recognition on impaired loans (i.e. unwinding procedures)
• Data systems
1-Required Reserve for Estimated Losses (i.e. prudential loan loss reserve); 2-Gone-concern debtors are those where liquidation of underlying collateral is more realistic recovery
strategy in comparison to repayment from operating cash flows for going-concern.
SDS Capital Impact on Aggregate Level 1/2
9
20,21 18,45
-0.86 -0.49 -0.14
-0.28
CAR Prior to SDS CFR and POF impact Collective provisioningimpact
Additional impact ofTier 2 capital decrease
SDS Adjusted CAR(Net impact)
Projection of findings
Credit File
Review
-176 bps
Note: Total IFRS adjustment impact has been presented here net of prudential loan loss reserve offset. Additionally, SDS adjusted CAR calculation did not include profit
for Q1 2015, and RWA has not been adjusted downwards to reflect corrections to asset carrying values (due to feasibility reasons). This makes the impact on SDS
adjusted CAR more conservative and is a specificity of this exercise. Finally, the impact of adjustment on one in-scope bank’s capital, as well as on other banks’
foreclosed portfolio is not explicitly shown in this image due to materiality reasons (~EUR 1 million per each bank, overall 1.6 bps).
SDS impact by component (in % of CAR)
SDS Capital Impact on Aggregate Level 2/2
10
Note: Other adjustments include the (net) reversals of individual IFRS provision for those exposures reclassified to collective assessment by consultants (the
amount of impact is presented here net of RREL addition and depicted as a negative number). POF adjustments on a gross basis amount to EUR 86 million and
Collective Provisioning adjustments amount to EUR 218 million.
Detailed breakdown of overall capital impact by components (in EUR million)
52
125
354
103 28
45
229
17 3
103 137
3 34 34
59 59
39
188
ReclasifiedNPE
Existing NPE-Going concern
Existing NPE-Gone concern
Total GrossImpact
RequiredReserve forEstimated
Losses Offsett
Otheradjustments
(net)
Projection ofFindings (net)
CFR & POFcapital impact
Collectiveassesment
(net)
Total SDSCapital Impact
Existing NPE –
going concern
Existing NPE –
gone concern
Going
Gone
137
196
80
Individual File Review
Existing NPEs
Reclassifications to NPE status
11
567
184
8
743
0
100
200
300
400
500
600
700
800
900
pre SDSNPE # of
clients
PE to NPEreclassified
NPE to PEreclassified
Total NPE
Num
ber
of
Debto
rs
14,1% 12%
16%
0%
5%
10%
15%
20%
25%
30%
35%
40%
45%
50%
SDS Average ECB 2014Average
ECB 2015Average (4
Greekparents)
+32%
Total CFR Reclassifications (number of debtors)
Reclassified NPEs (in % of originally performing debtors reviewed)
Note: In a number of cases debtors will hit more than one trigger. The assessment whether a reclassification to NPE is required is based on a holistic view of all triggers that impact a
debtor (or group of connected clients) simultaneously. The SDS Manual applied a set of common triggers across banks that were not necessarily applicable or consistent with the
banks’ interpretation of IFRS. Naturally, reclassifications to NPE status that are based on bank triggers are expected to be incorporated by the bank after SDS. However,
reclassifications done solely on the basis of NBS triggers leave room for judgment on behalf of the bank and its statutory auditor in the period after SDS.
Non-performing exposures
12
NPLs and NPEs pre and post SDS Sample of Corporate exposures
* There is an option in NPL reporting which stipulates „…where payments
are less than 90 days overdue, but the bank has assessed that the
borrower's financial state has deteriorated and that full repayment is
questionable, then the entire borrower is being considered as NPL“.
Banks use this option at their discretion and practices vary.
NPL Non-performing Loan
NPE Non-performing Exposure
Scope • Facility * • Debtor
Balance sheet coverage
• Loans (+accrued
interest and fees)
• All balance sheet
items
Off-balance sheet coverage?
• No • Yes
Materiality threshold on a debtor level?
• No • 20% of balance
sheet exposures
flagged as NPE
NPLs and NPEs under SDS Key methodological differences
28,71%
23,33%
NPL Corporate(1)
NPE Corporate(pre SDS) (2)
22,60%
27,30%
4,70%
Total NPL (1) ReclassificationsImpact
Estimated TotalNPL post SDS
(2)
NPLs vs NPEs (Corporate, pre SDS)
1-Total Corporate NPL amount prior to
SDS as reported by in-scope banks in
regular reporting to NBS; 2-Total
Corporate NPE in % on a sample of
corporate exposures selected during
SDS for in-scope banks (1.870 debtors
of which 743 flagged with NPE status)
1–Total aggregate NPL ratio for 14 in-scope
banks prior to SDS (includes retail and other
exposures etc.); 2- To existing stock of NPLs
(EUR 3.155 million) added the reclassified
balance sheet exposure (EUR 649 million)
and ratio recalculated.
Total NPL pre & post SDS (estimated size of reclassifications)
Importance of prudential regulation
• Safeguarding the financial system
– This aspect of domestic regulation reconfirms its validity and
highlights significance of such regulatory approach in the
context of maintaining the stability of individual institutions and
of the financial system as a whole.
• Absorbing additional impairments with prudential buffers
– Due to specific prudential regulation of NBS, substantial overall
SDS adjustments (close to 70%) in the part concerning
additional allowances for impairment in all three work blocks
were considerably absorbed by the reduction (offsetting impact)
in regulatory reserves for estimated losses.
13
What follows?
14
Key activities post SDS
15
Final SDS Reports per bank …
• Consultants have delivered to the NBS final SDS reports for each individual bank.
• In addition, these reports have been distributed by the NBS in full to the in-scope banks.
Issue of shortcomings that the Consultants have identified as part of their review of banks’ policies and practices …
• Consultants have in line with the TOR requirements given an overview of all qualitative findings,
apart from quantitative adjustments stemming from different work-blocks.
• Identification of qualitative issues in different domains (provisioning policies, collateral valuation
practices, data systems etc.) was followed by a proposed remediation activity and its priority
schedule.
• Banks are obligated to inform NBS in a written report about the SDS findings, their views on both
qualitative and quantitative findings by the 21 December 2015.
• NBS has already engaged in preliminary feedback discussions regarding both qualitative and
quantitative findings and all issues identified1 will be followed up by the NBS supervisory teams
and will be used in supervision going forward (in 2016 supervisory cycle);
Longer term SDS externalities …
• The NBS will use the studies to foster conservative implementation of IFRS accounting standards
and disclosure practices (such as enhancement of IAS 39 implementation in the form IAS 39
supervisory guidelines2).
• Moreover, it will use the experiences obtained to strengthen its prudential framework and
supervisory approach3.
1-banks will need to address other highlighted weaknesses in relevant policies and procedures, including accounting policies that are not deemed compliant with the letter and spirit
of IFRS, gaps in risk management and lending standards and corrections due to misalignment with prudential regulations of the NBS; 2-See more in NBS Action Plan for
Implementation of the NPL Resolution Strategy ; 3-NBS will seek to embed methodological aspects of the SDS in its supervisory procedures,