Supervisory Approaches

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to . Promote Early Loss . R. ecognition. Michael Moore. International Monetary Fund. October 2014. Vienna. These are the views . of the speaker . not necessarily . the IMF. 2. This session will discuss . ID: 532338 Download Presentation

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Supervisory Approaches




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Slide1

Supervisory Approaches to Promote Early Loss Recognition

Michael MooreInternational Monetary FundOctober 2014Vienna

Slide2

These are the views

of the speaker

not necessarily

the IMF

2

Slide3

This session will discuss

the supervisory complement to IFRS financial reporting

Context:

the great recessionBehind the curve – provisions and link to capitalDo supervisors have sufficient authority?Whose “judgment” is it?Policies and practice that augment accounting guidance – getting ahead of the curveOnsite supervision: testing bank practicesRules: non-accrual, charge-offs, & collateral treatmentMarkets: disclosure and transparency

Summary

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Slide4

Euro Area NPLs: What a drag

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IMF direct Blog: What a Drag: The Burden of Nonperforming Loans on Credit in the Euro Area

By Kerry, Portier, Ruggerone and Verkoren

Slide5

The stock of NPLs has doubled since 2009

N

ow more than euro 800 billion euro

Very little loan sales – less than 6 percentResolution is hampered by three factors:Bank financial capacity – capital and provisioning buffersBank operational capacity – deal with NPLs in houseLegal system capacity – bankruptcy, insolvency processes

Euro Area NPLs: What a drag

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Slide6

The GIIPS and the US

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Slide7

Provisions proved too little

7

Slide8

Enough capital ?

8

Slide9

Enough capital ? - Nope

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Slide10

The capital handcuffs - the October IMF-GFSR

Review of 300 banks in advanced economies found 25

_

percent did not have adequate capital to support lending growth of 5 percent a yearMost in Europe - about half the big banks (60 percent of assets)Why? Still nursing sick balance sheets that lack buffersTo dispose, restructure, collect NPLs, banks need to make provisions, but they need capital to make provisionsSome banks may have excess capital, but are slow to use it to deal with NPLs – supervisors need to compel thisBanks that are undercapitalized, will need to raise it – SSM hopefully answers this (?) (else its slow earnout)

Provisions and Link to Capital

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Slide11

Do Supervisors Have Sufficient Authority?

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Slide12

The

supervisor determines

that banks have adequate policies and processes for the early

identification and management of problem assets, and the maintenance of adequate provisions and reserves. The supervisorassesses whether the classification of the assets and the provisioning is adequate for prudential purposeshas the power to require the bank to adjust its classification of individual assetshas the power to require the bank to increase levels of provisioning, reserves, or capital…Muddled interpretation: What does the law say? Just capital, or is there a hook to provisioning?The supervisor’s strong bias needs to be provisions

BCP 18: Problem Assets - Provisions and Reserves

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Slide13

IAS 39 - Impairment triggers – seem sufficient and reasonable, also the role of judgment

Expert Judgment – “an entity uses

its

experienced judgment to adjust observable data for a group of financial assets to reflect current circumstances”Supervisors need to influence the judgment to:Ensure credible consistency across institutions on key metricsMandate adjustment to historical loss experience due to e.g., changes in the economy, property prices, unemployment rates IAS 9 - Is this really what we wished for?Even more complex models Even greater scope for variability in “judgment”

Whose “judgment” is it?

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Slide14

Supervisory policy and

p

ractice that

compliment accounting guidance

14

Slide15

Onsite evaluate effectiveness of bank’s credit risk policies and practices

Assess

that banks have in place effective systems to reliably classify loans on the basis of credit risk

Loan loss methodologies need to address both individually assessed and collectively assessed loansAssess validation of internal credit risk assessment modelsConclude views on model assumptions and expert judgmentsEvaluate information systems to ensure reliability

Onsite supervision: trust but verify

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Slide16

Remember when (in a pre-IFRS world) supervisory rules were suitable for the accounting standard

?

Illustrative Example

Standard Assets: 1% of the outstanding balance (Current to PD 90 days)Substandard Assets: 20% of the outstanding balance (PD 90-180 days)Doubtful Assets: 50% of the outstanding balance (PD 180-365 days)Loss Assets: 100% of the outstanding balance (PD > 365 days)

Supervisory policy: rules overlay

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Slide17

Supervisory policy: rules overlay

R

egulatory approach overlays accounting principles

Rules based treatments augment within the accounting standardsSome country examples:IrelandUnited StatesSpain

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Slide18

Supervisory policy: rules overlay (Cont.)

This looks familiar? *

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* Bank of Spain circular 3/2010 to simplify accounting provisions for Spanish financial institutions. Allows recognition for real estate guarantees with specified haircut according to collateral type (e.g., primary residence more valued than land).

Slide19

Supervisory policy: rules overlay (Cont.)

Ireland:

introduced a rule to prevent ever-greening of loans:

Renewal, refinancing, renegotiation, or restructuring of a credit facility will not interrupt the aging of arrears unless the borrower pays all interest without new financing.

19

Slide20

Supervisory policy: rules overlay (Cont.)

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United States: Non accrual and charge off policies

Nonaccrual

policy obliged by the supervisor:

Avoid overstatement of income & capital

Prompts early recognition of deterioration

Encourage management’s corrective actions

Non-accrual treatment applied with scope to restore accrual if circumstances change

Should promote prudent work outs

Banks are to promptly charge off identified losses

Slide21

Supervisory policy: rules overlay (Cont.)

United States: Non-accrual treatment

Suspension of interest for a loan that is 90

days in arrears unless well secured and in process of collectionCollection means legal action is proceeding and expected to result in recovery within the next 90 daysRestore to accrual if (i) loan is brought current, (ii) borrower makes sustained contractual payments (6 months), and (iii)_borrower likely to make all future contractual payments

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Slide22

Keeping up Appearances

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Example: effect of interest accrual on NPLs

Slide23

Keeping up Appearances

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Example Bank: effect of interest accrual on NPLs

Slide24

Supervisory policy: rules overlay (Cont.)

United States: Charge-off rule for retail credit

At 180 days in arrears, banks to charge off any loan

balance that exceeds the value of the property, less cost to sellCharge off is not forgiveness of principalCollection of charged off balances are recoveries (income)

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Slide25

The GIIPS and the US

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Slide26

Supervisory policy: rules overlay (Cont.)

United States: Treatment of foreclosed assets

When bringing the foreclosed asset onto the books

Charge-off further balance in excess of Fair Value less selling costs (net FV) – shouldn’t be much Transfer net FV from Loans to Other Real Estate Owned (e.g., bank-owned real estate)Subsequent valuation is lower-of-cost or market using valuation allowanceCompel prompt sale - banks must make good faith efforts to sell foreclosed properties at the earliest date (within five years)Special cautions when banks finance repossessed propertiesNo sale or gain if bank continues to control

26

Slide27

Supervisory policy: rules overlay (Cont.)

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* Bank of Spain circular 3/2010

Spain: treatment of real estate assets to compel

prompt sale*

Slide28

IFRS-IASB proposes extensive disclosures about expected losses and changes in the credit risk of the loan portfolio

Like Basel III, disclosure

enough to allow markets to understand the

nature of the NPLs, and provisioning. But what about frequency? Needs to be more frequent than annualDisclosures:Regulatory reporting: Supervisors should use regulatory reporting as a tool to disclose information to markets about individual institutionsMarket disclosures: should argue for quarterly reporting

Disclosure and transparency

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Slide29

Vigilance - capital and provision buffers needed to stay

ahead of the

curve

Overreliance on auditors equals complacencySupervisory and regulatory policy must complement accounting guidance to promote early recognitionOnsite supervision must test loan classifications, provisioning and capital models; as well question judgments and force adjustment to policy, practiceSupplement accounting guidance with prudential requirementsUse transparency as a tool to compel adjustment

Summary

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Slide30

Thank You

Michael Moore: Monetary and Capital

Markets

International Monetary Fundmmoore@imf.org

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