Consultation on Guidelines for Prudential Treatment of Problem Assets

The Basel Committee on Banking Supervision published a consultation document on guidelines for the prudential treatment of problem assets focusing on credit categorization definitions. In the context of the financial crisis, the Basel Committee noted that credit categorization terms used by firms were not always clear and made it difficult to compare financial information. This contributed to increased uncertainty at the height of the crisis and undermined investor ability to assess bank performance and risk. Credit risk categorization is a tool used by banks when assessing the solvency and riskiness of banks’ credit risk exposures. A Basel Committee task force determined that the two most important definitions for harmonization were “non-performing exposures” and “forbearance”. The Basel Committee has developed guidelines for the two definitions, built on commonalities in existing definitions, with the aim of providing clarity and guidance on qualitative and quantitative criteria for credit categorization. The definition non-performing exposure applies to exposures related to both on-balance sheet loans (e.g., debt securities and other amounts due that a bank includes in its banking book) and off-balance sheet items (e.g., loan commitments and financial guarantees). The Basel Committee listed the following as non-performing exposures: (i) all exposures “defaulted” under the Basel framework; or (ii) all exposures impaired (exposures that have experienced a downward adjustment to their valuation due to deterioration of their creditworthiness); or (iii) all other exposures not defaulted or impaired but that are more than 90 days past due or where there is evidence to suggest that full repayment is unlikely without collateral regardless of the number of days past due. 

The Basel Committee proposes that “forbearance” occurs when a counterparty is experiencing financial difficulty in meeting its financial commitments and a bank grants a concession that it would not otherwise consider, irrespective of whether the concession is at the discretion of the bank and/or the counterparty. There is now guidance as to the scope of concessions included in the definition of forbearance, including concessions extended to any exposure in the form of a loan, a debt, security or an off-balance sheet item (e.g., loan commitments or financial guarantees) due to the financial difficulties of the counterparty. The guidance also states that when determining cases of forbearance, banks should first determine if the counterparty is experiencing any financial difficulty. Even where there is no evidence to indicate that there are any amounts in arrears, other evidence of financial difficulty could include where a counterparty is currently past due on any of its material exposures, or despite not being past due, it is probable that the counterparty will become past due on its material exposures in the material future. The Basel Committee aims for the definitions to assist in the creation of benchmarks for, amongst others, supervisory asset quality monitoring, management internal credit categorization systems for credit risk management purposes and dissemination of data for asset quality indicators.  Responses to the consultation are due by July 15, 2016. 

View the consultation paper.