National Bank of Ukraine

The National Bank of Ukraine changed the approach to credit risk assessment by banks
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04 June 2016

Press Release

 

The National Bank of Ukraine by its Resolution No. 351 of 30 June 2016 approved the Regulation for Measuring Credit Risk Generated by Banks’ Asset Operations.

 

The aim of the new regulation is to ensure proper and timely assessment of credit risk by banks, which will strengthen their risk management, correct calculation of capital and, ultimately, improve the financial soundness of banks.

 

"Diagnostic study of the 20 largest banks showed that financial institutions often overestimated the financial capacity of borrowers and delayed the recognition of assets as non-performing. After the new regulation enters into force this practice will become a thing of the past. Credit risks of banks should be recognized in a timely manner and in full. Only in this case we will see an actual level of the banking sector capitalization," said Deputy Governor of the National Bank of Ukraine Kateryna Rozhkova.

 

The document provides for a new assessment of credit risk losses based on expected losses, not those already incurred by banks. In this respect, the new regulation is based on the Basel principles of banking supervision and complies with IFRS 9 (Financial Instruments), which also requires an assessment of the expected losses on financial instruments and will be implemented at the international level starting from 1 January 2018.

 

An important feature of the new regulation is a combination of clear and detailed rules and the general principles of credit risk assessment which allow the exercise of reasonable judgment by both the bank, and the regulator. It will prevent situations when banks do not recognize poor quality of their assets, referring to the formal rules. The key factor that will determine the quality of the asset will be the financial statements of the borrower.

 

"Implementation of the new regulation will practically make it impossible for banks to provide loans to insolvent companies, as well as to purchase securities of low-quality issuers, which was common practice in the past" said Director of the NBU Financial Stability Department Vitalii Vavryshchuk.

 

New regulation will replace the regulation in force on Procedures for Making and Using Provisions Against Possible Losses on Asset Operations by Banks of Ukraine, approved by NBU Board Resolution No.23 of 25 January 2012.

 

Adoption of this regulation is another NBU’s step towards the improvement of the regulation and supervision over the Ukrainian banking sector in accordance with the best international practice. Over a year, we have been jointly developing the regulation in cooperation with the banking community, and involving the IMF, World Bank, Oliver Wyman, and USAID experts.

 

For the calculation of expected loss the regulation provides for the use of formula, recommended by the Basel Committee on Banking Supervision, which includes three components: probability of default of the borrower (PD), loss given default (LGD) and exposure at default (EAD).The regulation takes into account the NBU findings on the practice of credit risk assessment by the banks, received, including as a result of diagnostic study of banks.

 

The regulation also provides for:

- the use of standardized approaches to the assessment of the financial standing of the bank borrowers (econometric scoring model for borrowers-legal persons, the list of qualitative and quantitative indicators for other borrowers);

- an assessment of the borrower’s credit risk based on the characteristics of the group of companies interlinked with the borrower through control relations or common economic risk. Today, the credit risk is assessed only on an individual basis for each borrowing company. Financial standing of a group of companies can both improve and deteriorate the borrowing company credit risk assessment;

- other factors of the credit risk identification (namely, timeliness of fulfilling the obligations by the borrower). If the signs of high credit risk trigger, the loan quality category will lower, even if econometric scoring model determines the loan as of the highest quality;

- expansion of the group (portfolio) assessment of assets and the determination of the main criteria for this assessment. Loans to legal entities and individuals in the amount up to UAH 2 million will be assessed by banks on a portfolio basis;

- enhanced requirements to the list of collateral and collateral eligibility. In particular, property rights (other than property rights on deposits) are excluded from the list of collateral, which banks can take into account when determining the credit risk.

 

The regulation will apply in test mode from 1 September 2016 and will be compulsory from 3 January 2017. Gradual introduction of new approaches to credit risk assessment will allow banks to develop internal policies and adjust IT systems. In addition, the banks and the NBU will be able to determine whether new approaches to the banks’ assets quality assessment are efficient and adjust them at the right time if necessary.

 

"Credit risk is the most significant banking risks. Inadequate assessment of credit risk by a bank could result in loss of capital and liquidity, threatening the interests of depositors and other creditors of the bank. For this reason, the NBU pays special attention to the adequacy of credit risk assessment by banks," said Nataliia Ivanenko the NBU Methodology Department Director.

 

 

For reference

 

According to the rules for regulatory capital calculation in force since 1 January 2016, if the estimated amount of credit risk exceeds total reserves for losses on asset-side transactions, formed under IFRS, the difference (unsecured credit risk) reduces regulatory capital.

 

This rule is based on the Principle 18 "Problem assets, provisions and reserves" of Core Principles for Effective Banking Supervision of the Basel Committee, which states that the supervisory authority must ensure that the reserves formed by banks under IFRS are sufficient in terms of banking supervision and fully meet the expected loss. Otherwise, the supervisor should require the increase of provisioning level or capital adjustment.


 

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