EMEA Financial Institutions 22 October 2014 Assessing A Banks Regulatory Environment And Its Loan Loss Provisions A Credit Rating Perspective Bank Ratings Framework Banking Industry Country Risk ID: 671787
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Slide1
Osman SattarDirector – Accounting SpecialistEMEA Financial Institutions22 October 2014
Assessing A Bank’s Regulatory Environment And Its Loan Loss Provisions: A Credit Rating
PerspectiveSlide2
Bank Ratings Framework:Banking Industry Country Risk Assessment
Economic RiskIndustry RiskBank-Specific FactorsBusiness Position
Capital & Earnings
Risk PositionFunding & LiquidityExternal FactorsGroup SupportGovernment SupportIFRS 9: Could Ballooning Loss Reserves Deflate Bank Capital Ratios?Appendices
Agenda
2Slide3
Bank Ratings FrameworkSlide4
Standard and Poor’s bank ratings framework is comprised of:Macro factors – the
Banking Industry Country Risk (BICRA) assessment.Bank-specific factors:
Business position;
Capital and earnings;Risk position; andFunding and liquidity.External support:Group support (from parent and/or other entities in the group); andExtraordinary government support.
Bank Ratings Framework
4Slide5
BICRA: The starting point for all bank ratings in a country.Scored on a scale from 1 (lowest risk) to 10 (highest risk).Comprises two main areas of (macro) analysis - economic risk and industry risk.
BICRA economic risk considers: Economic resilience; Economic imbalances;
Credit
risk in the economy.BICRA industry risk considers:Institutional framework; Competitive dynamics; System-wide fundingBank Ratings Framework – BICRA
5Slide6
Current BICRA, Economic Risk And Industry Risk Scores
Data as at 8 October 2014
6Slide7
Are lending standards “moderately conservative,” “relaxed,” or “aggressive”? E.g:
Household lending risk Share of new residential mortgage lending that is above 80% LTV.Average indexed LTV for residential mortgages.
Are underwriting standards based on multiple factors, or only a single one?
Share of non-prime mortgage lending?Corporate lending riskConcentrations in cyclical / vulnerable sectors (e.g. commodities, shipping).Extent of CRE construction & development lending.BICRA: Credit Risk - Lending And Underwriting Standards
7Slide8
Ability and track record of regulators in maintaining financial stability -
e.g
:
Scope of regulationGaps in regulatory coverage?Compliance with international standards?Effectiveness of supervisionSingle supervisor / close co-operation across supervisors?Systematic oversight (e.g. close and frequent monitoring) of banks?Regulatory track record:Past success in preventative measuresIdentifying problems at an early stage
BICRA: Institutional Framework – Banking Regulation And Supervision, Regulatory Track Record
8Slide9
Good corporate governance lowers the risk of a banking system.
Financial reporting:
Frequency and timeliness
Quality and standardizationAuditing rulesThe BICRA’s economic risk & industry risk scores determine a bank's Anchor Stand Alone Credit Profile (Anchor SACP) The Anchor SACP is the starting point in assigning the rating. It’s adjusted up or down the ratings scale after taking into account a bank's specific strengths and weaknesses in the bank-specific factors.
BICRA: Institutional Framework – Governance And Transparency
9Slide10
10From The BICRA To The Anchor
SACP - Examples
Poland:
Economic Risk: 5Industry Risk: 5Anchor SACP: bbb-
Hungary
:
Economic Risk: 9
Industry Risk: 7
Anchor
SACP: b+
Kazakhstan:
Economic Risk:
8
Industry Risk
:8
Anchor
SACP
: bb-
Ukraine:
Economic Risk: 10Industry Risk :10Anchor SACP
: b
-
Determining The Anchor
SACP
From Economic Risk And Industry Risk
Industry
risk
Economic risk
1
2
3
4
5
6
7
8
9
10
1
aaa-bbb+bbb+bbb2aa-a-bbb+bbbbbbbbb-3a-a-bbb+bbb+bbbbbb-bbb-bb+4bbb+bbb+bbb+bbbbbbbbb-bb+bbbb5bbb+bbbbbbbbbbbb-bbb-bb+bbbb-b+6bbbbbbbbb-bbb-bbb-bb+bbbbbb-b+7bbb-bbb-bb+bb+bbbbbb-b+b+8bb+bbbbbbbb-bb-b+b9bbbb-bb-b+b+b+b10b+b+b+bbb-
Data correct as at 8 September 2014Slide11
Bank Ratings Framework – Bank-Specific Factors
11
Bank-specific factors consist of:
Business position
Business stability
Concentration or diversity
Management and corporate strategy
Capital and earnings
S&P’s measurements of capital (Total Adjusted Capital,
TAC
) and risk-weighted assets to compute projected Risk-Adjusted Capital ratios (
RAC
ratios
)
Risk position
Funding and liquidity
The BICRA and bank-specific factors determine the bank’s stand-alone credit profile,
SACPSlide12
After the anchor SACP, consideration of each of the bank-specific factors can raise or lower the anchor
SACP by one or more notches - or have no effect in some cases (see table). These conclusions are expressed using specific rankings and descriptors
.
These rankings and descriptors, in turn, determine the number of notches to apply to the anchor SACP to determine the level of a specific bank's SACP.Bank-Specific Factors Adjust The Anchor SACP To Determine The SACP
12Slide13
Business position measures the strength of a bank's business operations. Business position is the combination of specific features of the bank's business operations that add to or mitigate its industry risk score.
Business position has 3 subfactors: Business stability;
Concentration
or diversity; and Management and corporate strategy.13Bank-Specific Factors – Business Position
Business Position
Subfactors
And Indicators
Subfactors
Explanation
Indicators
Business stability
The stability or fragility of a bank's franchise
Revenue stability, market shares, and the customer base
Concentration or diversity
The concentration or diversification of business activities
Contributions of different business lines and geographies to overall revenue
Management and corporate strategy
The quality of management, strategy, and corporate governance
Strategic positioning, operational effectiveness, financial management, and governance and financial policiesSlide14
14Bank-Specific Factors – Business Position
(cont’d)
Business Position Assessment
Qualifier
What it means
Very Strong
A bank’s business operations make it better placed to withstand adverse operating conditions than the industry risk score indicates.
Strong
A bank’s business operations make it somewhat less vulnerable to adverse operating conditions than the industry risk score indicated.
Adequate
A bank’s business operations are representative of the industry risk score.
Moderate
A bank’s business operations make it more vulnerable to adverse operating conditions than the industry risk score indicates.
Weak*
A bank’s business operations make it significantly more vulnerable to operating conditions than the industry risk score indicates.
Very Weak
The industry risk score is not representative of a bank’s vulnerability to adverse operating conditions. (This category applies only in exceptional circumstances.)
*The impact on the
SACP
is a deduction of two or three notches. Three notches applies only in the fragmented industries with a large number of smaller banks that all have weaker-than average industry risk. Deducting two or three notches from the
SACP
for a weak classification helps to differentiate such banks further. Slide15
Capital and earnings measures a bank's ability to absorb losses. Our analysis of capital and earnings comprises four steps:
Assessment of regulatory requirements; Future risk-adjusted capital
levels;
Quality of capital; andEarnings capacity.S&P’s projected risk-adjusted capital (RAC) ratio is the most important metric for our capital and earnings assessment:The RAC ratio compares a bank's capital to its risk-weighted assets (RWAs). Specifically, we use a globally consistent measure of capital, total adjusted capital (TAC) and S&P RWAs
.
15
Bank-Specific Factors –
Capital & EarningsSlide16
The assessment of risk position serves to refine the view of a bank's actual and specific risks beyond the conclusion arising from the standard assumptions in the capital and earnings analysis.
Those assumptions do not always reflect or adequately capture the specific risk characteristics of a particular bank.
The
analysis described in risk position is similar to that traditionally applied to assess the asset quality of a bank.Five areas are analyzed:Growth and changes in its risk positions;Risk concentrations or risk diversification;Complexity;Risks not covered by RACF
; andLoss experience and expectations
.
16
Bank-Specific Factors –
Risk PositionSlide17
Standard & Poor's uses its own projection of credit losses for each bank it rates in its ratings analysis. We factor:Our projected credit losses for each bank in our assessment of each bank's
SACP; andOur views about asset quality and the bank's relative capital position.
S&P’s credit
loss estimates are based on our calculation of loss given default (LGD) for each relevant asset class for the banking system as a whole. We apply the systemwide standard LGD calculations to all banks in a system. Yet, we realize that LGDs may vary greatly from bank to bank because of differences in the quality of loan portfolios and ability to recover losses. If we believe that these differences are significant, we factor them together with other factors into our assessment of the risk position of each bank.
Our LGD assumptions also take into account our assumptions about the average loan-to-value ratio that banks demand when extending credit, particularly to corporations and for residential mortgages
.
Bank-Specific Factors
– Risk Position: Estimating Credit Losses
17Slide18
The analysis of funding compares the strength and stability of a bank's funding mix, according to several metrics, with the domestic industry average. The liquidity analysis
centers on a bank's ability to manage its liquidity needs in adverse market and economic conditions and its likelihood of survival over an extended period in such conditions. The analysis is both absolute and relative to peers.
18
Bank-Specific Factors – Funding & LiquiditySlide19
19Bank-Specific Factors – Funding &
Liquidity (cont’d)
Funding Assessment
Descriptor
What it means
Above Average
A bank exhibits stronger funding metrics than the average for all banks in the same country.
Average
A bank exhibits similar funding metrics than the average for all banks in the same country.
Below Average
A bank exhibits weaker funding metrics than the average for all banks in the same country.Slide20
Assessment of:Likelihood for future extraordinary government support. Likelihood for future extraordinary group support.
Bank Ratings Framework – External Support
20Slide21
IFRS 9: Could Ballooning Loss Reserves Deflate Bank Capital Ratios?Slide22
Moving to IFRS 9 will result in an earlier recognition of credit lossesHigher
credit loss allowances decrease banks' capital. All else being equal, our analysis suggests that among the top 100 global banks we rate, western
European banks could see core tier 1 ratios falling by an average of
53bps for each 10% rise in reserves.The new rules changes could lead some banks to shift loan product strategies, e.g.Favoring shorter-duration loan products over longer-term loan products to achieve a more favorable accounting outcome. In extreme cases, bank
management may decide to curtail the underwriting of new loan products.
Higher Credit Losses May Have A Meaningful Impact On Bank Capital
22Slide23
Impact On Core Tier 1 Ratios From Rising Credit Loss Allowances For Top 100 Rated Banks, By Region
For
each
10% rise in allowances:Western European banks' core tier 1 ratios fall by 53bps on average;EEMEA: average fall of 17bps
;US: 12bps;
Canada:
10bps
;
APAC:
16bps;LatAm: 35bps
23Slide24
Regional Differences Could Be Due To Many Factors
The differences in the magnitude of the capital impact across banks in different regions result from a combination of factors, including:Differences in business models:
There is generally a greater level
of disintermediation in U.S. banks compared with European banks, with the latter retaining a relatively larger proportion of loans on their balance sheets.Differences in asset write-off policies:Legal processes such as foreclosure tend to be slower in some jurisdictions (such as countries in southern Europe), so it can take longer for impaired assets to be written off from the balance sheet. Therefore, banks in such jurisdictions often carry high levels of provisioning against impaired assets for a longer time.
24Slide25
IFRS 9 requires a dual-measurement approachRecognition of an
initial (day 1) credit loss allowanceRepresents 12 months of expected credit losses for all financial assets in the scope
of the
model, updated at each reporting period. Recognition of lifetime expected credit lossesOnly if and when management decides the credit risk of the financial asset has significantly increased since its initial recognition.This means that, for assets that are performing as banks originally expected - including the vast majority of most banks‘ loan portfolios -the model would only reflect a portion of expected credit losses.
The dual-measurement approach will also lead to
inconsistencies
across banks
Because
the judgments bank managements apply about whether assets have experienced significant increases in credit risk are likely to vary and may be subject to bias (e.g., where management may be influenced by earnings targets).
The IFRS
9 Credit Loss Model Does Not Go Far Enough
25Slide26
Appendices: - S&P Rating Scales-
BICRAs By Group And Country- Selected S&P publicationsSlide27
Appendix: S&P Rating Scales
27Slide28
Appendix: BICRAs By Group And Country
Data as at 8 October 2014
28Slide29
Research:Could Ballooning Loss Reserves From New Accounting Rules Deflate Bank Capital Ratios?
Sep. 9, 2014Banking Industry Country Risk Assessment Update: October 2014, Oct 8, 2014
Criteria:
Banks: Rating Methodology And Assumptions, Nov. 9, 2011Banking Industry Country Risk Assessment Methodology And Assumptions, Nov. 9, 201129Appendix: Selected S&P
PublicationsSlide30
Thank YouOsman Sattar
Director – Accounting Specialist, EMEA Financial InstitutionsT: +44 (0)20 7176 7198osman.sattar@standardandpoors.com Slide31
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