Minimum Capital Requirements for Credit Risk

Banks must regularly compare realized default rates with estimated PDs for each grade and be able to demonstrate that the realized default rates are within the expected range for that grade. Banks using the advanced IRB approach must complete such analysis for their estimates of LGDs and EADs. Such comparisons must make use of historical data that are over as long a period as possible. The methods and data used in such comparisons by the bank must be clearly documented by the bank. This analysis and documentation must be updated at least annually. 16.123 Banks must also use other quantitative validation tools and comparisons with relevant external data sources. The analysis must be based on data that are appropriate to the portfolio, are updated regularly, and cover a relevant observation period. Banks’ internal assessments of the performance of their own rating systems must be based on long data histories, covering a range of economic conditions, and ideally one or more complete business cycles. 16.124 Banks must demonstrate that quantitative testing methods and other validation methods do not vary systematically with the economic cycle. Changes in methods and data (both data sources and periods covered) must be clearly and thoroughly documented. 16.125 Banks must have well-articulated internal standards for situations where deviations in realized PDs, LGDs and EADs from expectations become significant enough to call the validity of the estimates into question. These standards must take account of business cycles and similar systematic variability in default experiences. Where realized values continue to be higher than expected values, banks must revise estimates upward to reflect their default and loss experience. 16.126 Where banks rely on supervisory, rather than internal, estimates of risk parameters, they are encouraged to compare realized LGDs and EADs to those set by SAMA. The information on realized LGDs and EADs should form part of the bank’s assessment of economic capital. Section 9: Supervisory LGD and EAD Estimates 16.127 Banks under the foundation IRB approach, which do not meet the requirements for own-estimates of LGD and EAD, above, must meet the minimum requirements described in the standardized approach to receive recognition for eligible financial collateral (as set out in the credit risk mitigation section of the standardized approach, chapter 9 ). They must meet the following additional minimum requirements in order to receive recognition for additional collateral types. Definition of eligibility of commercial and residential real estate as collateral 16.128 Eligible commercial and residential real estate collateral for corporate, sovereign and bank exposures are defined as: (1) Collateral where the risk of the borrower is not materially dependent upon the performance of the underlying property or project, but rather on the underlying capacity of the borrower to repay the debt from other sources. As such, repayment of the facility is not materially dependent on any cash flow generated by the underlying commercial or residential real estate serving as collateral; and (2) Additionally, the value of the collateral pledged must not be materially dependent on the performance of the borrower. This requirement is not intended to preclude situations where purely macro-economic factors affect both the value of the collateral and the performance of the borrower. 16.129 In light of the generic description above and the definition of corporate exposures, income producing real estate that falls under the SL asset class is specifically excluded from recognition as collateral for corporate exposures. 68 Operational requirements for eligible commercial or residential real estate