RESPONSE TO FEEDBACK RECEIVED - CONSULTATION PAPERS ON INTERNAL-RATINGS BASED APPROACH
1 General Comments
1.1 As part of the process to implement the Revised Basel Capital Framework (commonly referred to as "Basel II") in Singapore, MAS has issued consultation papers inviting comments on the proposed definition of default (30 July 2004), rollout and exclusions (25 August 2004) and asset-class definitions and size limits (8 September 2004) for the internal-ratings based approach ("IRB"). The consultation periods for the three papers closed on 31 August 2004, 30 September 2004 and 6 October 2004 respectively.
1.2 We thank all respondents for their comments. The comments on the 30 July 2004 and 8 September 2004 consultation papers that are of wider interest and our responses are set out below. The comments on and our responses to the 25 August 2004 consultation on rollout and exclusions have been incorporated into MAS' guidelines "IRB Adoption: Supervisory Permission and Rollout Parameters" published today.
Definition of Default
2 Liquidation of Collateral
2.1 MAS proposed that a bank should record a default if collateral is liquidated to satisfy a credit obligation, with the proviso that a bank may choose not to record a default if: (a) the facility had been granted to finance an investment in a financial instrument which was then pledged as collateral, and (b) the collateral was liquidated to restore an agreed collateral coverage ratio. Some respondents suggested that a bank should have discretion whether to record a default in the event of collateral liquidation, regardless of whether the facility was used to finance an investment position
MAS' Response
2.2 When extending credit to a borrower, it is generally recognised that liquidation of the collateral is the secondary source of repayment of the loan by the borrower; the first being the borrower's own financial resources. In other words, when collateral has to be liquidated, the borrower would typically be experiencing difficulties in repaying the loan from his own financial resources. MAS' proposal, however, recognises that for certain types of lending activity that have the substance of financing of investments in financial instruments), it is normal for banks to look to the liquidation of the collateral pledged as the primary source of repayment of the facility and therefore this may not be indicative of a default of the borrower. Given the above, it would not be appropriate to make the concession available irrespective of the purpose and type of the facility.
3 Material Credit Loss
3.1 MAS sought banks' views on how the indication of default based on a material credit loss could best be implemented. One bank proposed using a credit-related loss of 20% or more of the original book value of the facility as an indicator of a material credit loss. Other respondents felt that it would be difficult to set a fixed materiality threshold owing to the variety of credit and non-credit factors that would affect asset values.
MAS' Response
3.2 After considering the feedback received, MAS has decided not to prescribe loss thresholds for determining a material credit loss for the moment. A bank using IRB will need to implement internal policies to determine when a material credit loss has been incurred and track the performance of such policies over time. MAS will examine these internal policies in connection with a bank's application to adopt IRB.
4 Additional Indications of Default
4.1 MAS proposed that acceleration of an obligation be included as an additional indication of default. Some respondents suggested that "acceleration" should be linked to an event of default or a payment default.
MAS' Response
4.2 MAS does not consider such clarification necessary. Acceleration is typically a remedy available to a bank after the occurrence of an event of default as defined in the facility agreement. Linking acceleration to a payment default is also unnecessary as a payment default, if uncured, will eventually breach the 90 days past due default threshold.
4.3 MAS also proposed that a default by an obligor on credit obligations to other financial creditors be used as an indicator of default. One respondent suggested that this should be clarified as "default by an obligor on credit obligations to other financial creditors based on publicly available information" as the bank may not otherwise be aware of such defaults.
MAS' Response
4.4 MAS accepts the proposal.
Asset-class Boundaries
5 Residential Mortgage Loans
5.1 MAS proposed to adopt the Basel II requirement that residential mortgage loans comprise only exposures to individuals that are owner-occupiers of the residential property being financed. This means that loans extended to individuals who are not owner-occupiers, loans secured by uncompleted properties and loans to corporates will be excluded.
5.2 Respondents suggested that where project account rules mitigate completion risk, loans secured by uncompleted properties should be treated as residential mortgage loans. One respondent stated that it did not currently distinguish between owner-occupied and buy-to-let properties, citing practical difficulties in obtaining such information.
MAS' Response
5.3 After considering the feedback received, MAS will permit all exposures to individuals secured by residential mortgages that meet the criteria in MAS Notice 637 to be risk-weighted at 50% to be treated as residential mortgage loans.. Nonetheless, an IRB bank will be required to track this sub-asset class as 3 portfolios: completed owner-occupied residential properties, completed non-owner occupied properties, and uncompleted properties. This will enable banks eventually to overcome current data limitations.
6 Thresholds for Qualifying Revolving Retail Exposures, Small Business Exposures and SME Size Adjustment1
6.1 The consultation paper contained the following proposed thresholds:
- Maximum exposure to a single individual for qualifying revolving retail exposures - S$100,000
- Maximum exposure for small business exposures classified under retail - S$1 million
- Total annual sales for SME firm-size adjustment - S$5 million to S$50 million
6.2 Respondents found the proposed thresholds low relative to current business practices and raised concerns about cross-border consistency.
MAS' Response
6.3 After considering the feedback received, MAS has revised the thresholds as follows:
- Maximum exposure to a single individual for qualifying revolving retail exposures - S$200,000
- Maximum exposure for small business exposures classified under retail - S$2 million
- Total annual sales for SME firm-size adjustment - S$10 million to S$100 million2
6.4 Banks are expected to comply strictly with the thresholds, and re-classify accordingly exposures that exceed the thresholds.
7 Quality of Financial Information Used in Firm-size Adjustment
7.1 MAS proposed that the sales figure used for the SME firm-size adjustment should be audited and not more than 18 months old. Some respondents suggested that unaudited figures that a bank uses in its credit process and figures up to 24 months old should be permitted for practical reasons.
MAS' Response
7.2 MAS is of the view that unaudited figures are not sufficiently reliable for the purposes of calculating regulatory capital requirements. Therefore, the use of unaudited figures will not be allowed. MAS expects banks to endeavour to use audited figures that are not more than 18 months old. However, audited figures that are not more than 24 months old will be admissible under exceptional circumstances.
8 Basis of Consolidation for Small Business Exposures
8.1 MAS proposed that the basis of consolidation should be the definition of a borrower group used by each bank, with the proviso that exposures to sole proprietors and partners be included. Some respondents felt that consumer loans to sole proprietors and partners should be excluded from the consolidation.
MAS' Response
8.2 MAS takes the view that a blanket exclusion of consumer loans to sole proprietors and partners can lead to an inappropriate measure of risk. For example, when lending to a sole proprietor, the source of repayment for both the consumer and small business loans may be indistinguishable. Furthermore, such loans can be fungible across personal and business uses.
8.3 Therefore, MAS will generally require an IRB bank to consolidate the business and personal exposures of sole proprietors and partners. However, MAS may permit a bank to de-consolidate certain exposures if the bank can demonstrate that the de-consolidated obligors have independent debt-servicing ability. A simplistic de-consolidation based on product type alone will not be acceptable.
MONETARY AUTHORITY OF SINGAPORE
11 January 2005
LIST OF RESPONDENTS TO PUBLIC CONSULTATION
ABN AMRO Bank N.V.
Accenture
DBS Bank Ltd
Oversea-Chinese Banking Corporation Ltd
PricewaterhouseCoopers
The Hongkong and Shanghai Banking Corporation Ltd
United Overseas Bank Ltd
1 One respondent asked MAS to clarify what threshold it would set for aggregated retail exposure to one customer under the Standardised Approach. The issue will be dealt with in a consultation paper on the Standardised Approach that MAS will publish in 2005.
2 The respective thresholds proposed by the Basel Committee on Banking Supervision are EUR100,000 (approximately S$220,000), EUR1 million (approximately S$2.2 million) and EUR5-50 million (approximately S$11-110 million). While current exchange rates would suggest higher thresholds, MAS has rounded down the translation rate to the nearest integer, i.e., S$2: EUR1, for convenience.
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