on Banking Supervision
Guidelines
Prudential treatment of problem assets – definitions of non-performing exposures and forbearance
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This publication is available on the BIS website (www.bis.org).
© Bank for International Settlements 2016. All rights reserved. Brief excerpts may be reproduced or translated provided the source is stated.
ISBN 978-92-9197-487-0 (print) ISBN 978-92-9197-488-7 (online)
Executive summary ……………………………………………………………………………………………………………………………………………………… 1
Purpose and use of the common definitions ………………………………………………………………………………………… 3 Mandate………………………………………………………………………………………………………………………………………………………..3 Purpose and use of the common definitions ………………………………………………………………………………………… 3
Main harmonisation features of the definitions of non-performing exposures and forbearance . 6 Main harmonisation features of the definition of non-performing exposures……………………………….. 6 Main harmonisation features of the definition of forbearance ………………………………………………………….. 7
Definition of non-performing exposures ……………………………………………………………………………………………….. 8 Identification of non-performing exposures………………………………………………………………………………………….. 8 Recategorisation of non-performing exposures as performing ……………………………………………………….10 Additional considerations…………………………………………………………………………………………………………………………11
Definition of forbearance………………………………………………………………………………………………………………………….12 Identification of forbearance……………………………………………………………………………………………………………………12 Criteria for exit from the forborne exposures category………………………………………………………………………14 Interaction of forborne exposures with non-performing exposures………………………………………………..14
Annex: Stocktake of key terms and practices on credit risk categorisation for loans …………………………………..15 Summary of main findings ……………………………………………………………………………………………………………………………………….15 Part I – System issues…………………………………………………………………………………………………………………………………………………18 Part II – Thematic review of key terms……………………………………………………………………………………………………………………26 Case studies…………………………………………………………………………………………………………………………………………………………………38
Guidelines for definitions of non-performing exposures and forbearance iii
Executive summary
(i) The global financial crisis revealed difficulties for supervisors and other stakeholders in identifying and comparing banks’ information across jurisdictions. In particular, the on Banking Supervision recognised that there may be significant differences in how banks identify and report their asset quality.
(ii) In response to this issue, the formed a dedicated task force to analyse jurisdictions’ and banks’ practices regarding asset categorisation schemes – the system that requires loans to be grouped based on their credit quality – and to assess the consequences of any differences in practices.
(iii) The analysed the regulatory frameworks and supervisory practices across jurisdictions through a literature review and a survey of 28 supervisors,1 as well as industry practices through a questionnaire and case studies sent to 39 banks from the 28 jurisdictions.
(iv) The literature review and the outcome of the survey questionnaires confirmed that banks categorise problem loans in a variety of ways. There are no consistent international standards for categorising problem loans.
(v) In addition, the analysis revealed varying practices across jurisdictions, as well as various layers of definitions within jurisdictions. In particular, it noted differences in the definitions of terms used in the accounting and regulatory frameworks, such as the concept of impairment or the definition of default used for modelling purposes. The analysis also identified that more than half of the jurisdictions included in the survey had established local/national supervisory definitions for asset categorisation different from those used in the accounting framework and/or the definition of default in order to achieve consistent supervisory reporting and disclosure on asset quality driven by prudential considerations.
(vi) Against this background, the developed guidelines for the definitions for two important terms – “non-performing exposures” and “forbearance”. The definitions are built on commonalities in the existing definitions of many countries. These will help harmonise the quantitative and qualitative criteria used for credit categorisation and provide the starting point for countries with no existing definitions to develop them.
(vii) The definition of non-performing exposures introduces harmonised criteria for categorising loans and debt securities that are centred on delinquency status (90 days past due) or the unlikeliness of repayment. It also clarifies the consideration of collateral in categorising assets as non-performing. The definition focuses on a debtor basis, but allows categorisation of exposures as non-performing on a transaction basis for retail exposures. It also introduces clear rules regarding the upgrading of a non-performing exposure to performing and the interaction between forbearance and non-performing status. The definition of forbearance provides a harmonised view on the modification or refinancing of loans and debt securities that result from a borrower’s financial difficulty. The definition allows forborne exposures to be categorised as performing or non-performing exposures. It also sets out criteria for the discontinuation of the forbearance categorisation and emphasises the need to ensure a borrower’s financial soundness before the discontinuation.
Surveyed jurisdictions include Thailand and the 27 jurisdictions that are members of the .
Guidelines for definitions of non-performing exposures and forbearance 1
These guidelines are intended to complement the existing accounting and regulatory framework in relation to asset categorisation. They will harmonise the scope, recognition criteria, and level of application of both terms, thereby promoting a better understanding of the terms, improving identification and monitoring, and promoting consistency in the supervisory reporting and disclosures by banks. The definitions are intended to be used in the following contexts:
• Supervisory asset quality monitoring, including so that supervisory colleges can obtain a more consistent basis for comparison across jurisdictions;
• Banks‘ internal credit categorisation systems for credit risk management purposes;
• Pillar 3 disclosure on asset quality;2
• Dissemination of data for asset quality indicators; and
• A reference point for other relevant working groups of the .
In turn, this will help supervisors and banks’ management to identify levels of non-performing and forborne exposures in absolute and relative terms and facilitate timely action to address rising asset quality problems.
Specific disclosure proposals will be considered as part of the ’s ongoing review and update of the Pillar 3
requirements.
Guidelines for definitions of non-performing exposures and forbearance
1. Purpose and use of the common definitions 1.1. Mandate
1. One of the lessons learnt from the financial crisis is that supervisors and investors could not always understand and compare information about credit categorisation presented in banks’ financial statements. Banks used different (and often undisclosed or insufficiently disclosed) methodologies and assumptions for valuations, provisioning and risk weightings, increasing opacity and reducing comparability for end users. This inconsistency increased uncertainty at the height of the crisis and frustrated supervisors and investors who tried to compare and assess banks’ performance and risk.
2. The on Banking Supervision formed a task force to analyse the range of practices with respect to the definitions of credit risk management terms, their use in credit categorisation3 schemes by banks and their supervisors, and the causes and consequences of differences. The task force gathered information on the use of such key terms as “weakened”, “forbearance”, “non-performing loan”, “loss” and “write-off” via literature reviews and survey questionnaires and case studies sent to banks and supervisors. These terms are used in credit categorisation schemes – where loans are grouped based on their credit quality – as a key component of internal credit risk management, and in supervisory reporting and public disclosure.
3. The survey of loan categorisation practices indicated that credit categorisation schemes and the terms, as well as their definitions, varied widely across jurisdictions and banks. Practices varied due to the absence of a consistent international framework guiding banks and supervisors in categorising problem loans. The significant influence of local accounting, regulatory, legal or tax standards leads to situations where one category bearing the same name in different jurisdictions or banks does not actually cover loans with the same degree of creditworthiness. This occurred due to different criteria for including loans in the category. More information on the survey of loan categorisation practices is provided in the Annex.
4. Following the initial research, the has developed guidelines for common definitions for the two most important terms assessed – “non-performing exposures” and “forbearance”. The definitions are built on commonalities in existing definitions, and they aim to provide clarity in terminology and guidance on quantitative and qualitative criteria for credit categorisation. In addition, the definitions help improve the identification and monitoring of non-performing exposures and forbearance as well as promote consistency in supervisory reporting for these two key categories of asset quality.
5. The did not develop common definitions for three other terms that were analysed, ie “weakened”, “loss” and “write-off”. This reflected a lower degree of commonality and conflicts with jurisdictions’ local, legal and tax considerations.
1.2. Purpose and use of the common definitions
6. Credit risk categorisation is a supervisory and bank management tool used to assess the solvency and the riskiness of banks’ credit risk exposures. It helps identify credit risk-related issues that require management or supervisory action. Thus, differences across jurisdictions in credit categorisation schemes and practices are detrimental in several ways:
This document uses “categorisation” in order to avoid confusion with the concept of classification (eg “classified loans” or
“adversely classified” loans) used in some jurisdictions as a supervisory tool and in the accounting framework.
Guidelines for definitions of non-performing exposures and forbearance 3
• At a bank level, they can make it difficult to properly assess credit risk and can delay early detection of an increase in credit risk (deterioration of asset quality) and its consequences, particularly when supervising a cross-border bank with activities in jurisdictions using different credit categorisation schemes. For example, figures at the consolidated level may result from the aggregation of non-comparable asset quality data from different jurisdictions.
• At a system-wide level, they make international comparisons very challenging for supervisors, multilateral public bodies and market analysts. They can also raise questions about the comparability of common indicators used to benchmark asset quality at the global level, such as the IMF Financial Soundness Indicator on non-performing loans.
• At the Basel standards level, they can influence the implementation and assessment of compliance with Principle 18 (“Problem assets, provisions and reserves”), as different credit risk categorisation requirements and practices create different incentives to act early on problem assets, and initiate supervisor responses, which can ultimately lead to an unlevel playing field.
7. Enhanced comparability of terminology and the resulting harmonisation of practice enables supervisors and market participants to better understand asset quality issues, including on a cross- border basis and relative to other jurisdictions. Common definitions help set a consistent basis for supervisors to understand levels of problem loans as they discuss and consider supervisory responses.
Interactions with the other credit quality concepts under the Basel and accounting frameworks
8. The ’s definitions of non-performing exposures and forbearance are intended to complement the other existing accounting or regulatory concepts of credit categorisation on credit quality.
9. The definitions form a more consistent supervisory basis for the identification of problem loans, regardless of the risk of loss. They are designed to complement existing accounting standards used in various jurisdictions, and in no way undermine standards that are focused on the accuracy of impairments and provisions disclosed in financial statements and reflect the risk of loss. Nor are they designed to replace the existing definitions of default used in the Internal Ratings-Based (IRB) approach and the proposed standardised approach for credit risk. The definitions are focused on a single set of criteria that can be used for comparative purposes. The definition of non-performing exposures is designed to be used alongside the definition of forbearance, which in itself can be categorised as either performing or non-performing based on the criteria outlined here.
10. The definition of non-performing exposures is intended to complement the current categories of “past due” and “defaulted” in the Basel framework (paragraphs 75 and 452, respectively).
11. In this regard, the definition of non-performing exposures builds on the definition of default but, for the purpose of categorising loans into reasonably simple categories, is broader than that definition in the following ways: (i) it is based on a standard 90 days past due (DPD) threshold, while the default definition used in the IRB approach allows for the use of a 180 DPD threshold for retail and public sector exposures; (ii) it offers more harmonised recategorisation criteria than those currently existing under the definition of default; and (iii) it offers more specific guidance regarding the interaction of forbearance measures and non-performing status.
12 There are certain obstacles for effectively using the definition of default for a common understanding of problem loans: (i) it leaves to banks the specific recategorisation criteria from a defaulted category to a non-defaulted category; (ii) it covers only cases of distressed restructuring that inflict a loss on a bank; and (iii) it is open to various interpretations (eg there can be different interpretations about an exposure’s default status when it is impaired, especially for non-significant exposures when impairment may be recognised on a portfolio basis). These two important elements – restructuring and impaired status – are specified by national guidance.
4 Guidelines for definitions of non-performing exposures and forbearance
13. While the revised standardised approach proposes to enlarge the definition of default to exposures under the standardised approach, the proposed definition differs from the definition used in the IRB approach as regards primarily the past-due indicators.
14. The definition of non-performing exposures, on the other hand, is designed to uniformly apply to all jurisdictions regardless of the regulatory approach applied to credit exposures. It is a harmonised asset quality indicator that can provide an asset quality comparison across jurisdictions and is indifferent to a jurisdiction’s stage of implementation of the different versions of the Basel framework, including use of internal credit models.
Specific benefits from the definitions of non-performing exposures and forbearance
15. The definitions of non-performing exposures and forbearance harmonise the scope, categorisation criteria, and level of application of both terms, and they provide benchmarks for use in the following contexts:
• Supervisory asset quality monitoring;
• Banks’ internal credit categorisation systems for credit risk management purposes;
• Potentially Pillar 3 disclosure on asset quality;4
• Dissemination of data for asset quality indicators and international assessments of financial systems; and
• A reference point for other relevant working groups of the .
16. Thus, the harmonised definitions and guidelines for non-performing exposures and forbearance are expected to be used by supervisory authorities and banks to monitor and assess banks’ asset quality, in a consistent manner, both within and across jurisdictions. The new definitions will also facilitate effective discussion of asset quality within cross-border banking groups in colleges of supervisors. In turn, they will provide an internationally consistent reference point for supervisors and banks’ management in identifying levels of non-performing and forborne exposures in absolute and relative terms and facilitate timely action to address rising asset quality problems. Such measures may include increasing coverage ratios, improving arrears management and workout systems, and setting targets for reducing non-performing levels. To this end, the Committee expects that the guidelines will be applied to internationally active banks at a minimum, and wider application is permitted at a supervisor’s discretion.
17. The definitions also provide a key foundation for those countries currently without definitions of non-performing exposures and forbearance, and if the information is disclosed, it will also play an important role in influencing market discipline through transparency.
18. These definitions may also be used, if so desired, as reference points for regulatory and accounting concepts (eg default and impairment) to promote comparability for risk-weighting, provisioning and credit loss recognition.
Specific disclosure proposals may be developed by the as part of its ongoing review and update of the Pillar 3 requirements. In the meantime, banks can use the definitions of non-performing and forbearance to complement some of the requirements of the revised Pillar 3 framework released in January 2015, especially in Table CRB, which requires information on impaired, past-due, defaulted and restructured exposures.
Guidelines for
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