Credit Risk Credit Risk Credit Risk Credit Risk Management 1866

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Explan at ion of check point sExplanation of check pointsExplan at ion of check point sExplanation of check points

1. Unless explicitly stat ed otherwise, items expressed in the question form such as does the institut ion or is the institution are minimum sta ndards tha t

ar e expected of all financial inst itu tions. Inspectors, a s th ey go th rough t heir checklists , need to fully verify the effectiveness of th ese item s.2. Unless explicitly sta ted other wise, items worded in the form of it would be desira ble tha t const itute best practice for all finan cial institut ions.

Inspectors need only confirm these items.

3. Items that are a combination of the two represent minimum standar ds for internat ionally active banks (those financial institutions calculating their

capital adequa cy ra tios a ccording to the Basle sta nda rds) but ser ve only as best pra ctices for other finan cial instit utions (those calculating their capital

adequa cy ratios according t o domestic sta ndar ds).

Distinction betweenDistinction betweenDistinction betweenDistinction bet ween board of directorsboar d of directorsboard of directorsboar d of directors an dandandand board of directors etc.boar d of directors et c.board of directors et c.boar d of directors et c.

1. Items tha t a re defined as roles of the board of directors are items for which th e board of directors itself needs to determine all essential matt ers. This

does not, however, preclude the board of directors from delegating consideration of draft documents to the management committee or similar bodies.

2. The phrase board of directors etc. includes the board of directors, the ma nagement committee, the business steering committee, and similar bodies.

Item s th at ar e defined a s roles of the boar d of directors et c. would ideally be deter min ed by the boar d of directors its elf, but ma y be delegat ed to the

ma na gement comm ittee etc. provided tha t t here h as been a clear delegation of this aut hority from th e boar d of directors, th e man agement comm ittee etc. has

kept m inut es of its pr oceedings and other ma teria ls tha t would allow after-the-fact confirmat ion, an d th ere a re a dequate int erna l contr ols in place, e.g., the

results a re reported to the board of directors, and au ditors a re allowed to par ticipat e in the ma nagement comm ittee etc.


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ItemItemItemItem Risk Management System Check PointRisk Management System Check PointRisk Management System Check PointR is k Managemen t Sys tem Check Point Exp lana t ion of R is k Management Check Point sExplanation of Risk Man agement Check P ointsExplanation of Risk Management Check PointsExplanat ion of Risk Management Check Poin ts RemarksRemarksRemarksRemarks

2. Awar eness a nd r oles of seniormanagement

(1) Est ablishmen t of ru les for riskmanagement

(1) Does senior mana gement est ablish ru les for creditrisk ma nagement in a ccordance with credit r isk

man agement p olicies and with th e approval of th e

board of directors et c? Does it r eview these r ules a s

necessary?

Do rules for credit risk man agement include the

scope of lendin g, credit ra tios, portfolio

management, decision-making authority, screening

guidelines, credit au dit met hods and other relevant

matters?

Note: Senior man agement

refers to bra nch office mana gers

and persons in senior ma nagerial

positions (including directors)

with equ ivalent levels of

responsibility, and so thr oughout .

(2) Appropr iate r isk management pract ice (2) Does senior ma na gement pra ctice effective creditrisk ma na gement in individual divisions in

accordan ce with risk m an agement policies and risk

mana gement rules, and does it bear the

responsibility for risk ma na gement?

It is desirable tha t int erna l models etc. based on

credit ra tings be used t o quan tify credit r isks for

credit risk mana gement purposes, and that the

institution set credit risk limits commensura te t o

appr opriate pr ofitability, allocations of mana gerial

resources, an d capital adequa cy.It is also desirable tha t such systems have adequat e

computer system support.

II .II .II .II . Esta blishment of appropriateEsta blishment of appropriateEsta blishment of appropriateEsta blishment of appropriaterisk management systemsrisk mana gement systemsrisk management systemsrisk mana gement systems

1. Awareness and evaluation ofrisk

(1) Esta blishment of integrated r iskman agement systems

(1) Does the institution practice integrated credit riskmana gement t hat includes, to the extent permitt ed

und er applicable laws an d ordina nces, its

consolidated subsidiar ies and su bsidiaries falling

under t he equity method?

Does th e institu tion practice integrat ed

man agement th at covers not only lending but a llasset s an d off-balan ce-sheet it ems for which th ere

ar e credit r isks including the credit risks associated

with mar ket tr ansactions)?


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(2) Evalu at ion of new products andactivities

(2) When int roducing new products and a ctivities, doesth e risk man agement d ivision evalua te th e locus etc.

of credit r isk, seek opinions from t he legal a ffairs

division an d in spections division etc. when

necessary, report t o the board of directors et c. on its

risk evalua tion findings, and seek t he appr oval of

th e board of directors etc. for th e int roduction of new

products and a ctivities?

2. Screening and management (1) Esta blishment of screening an dman agement system

(1) Is th e screening and mana gement division insulat edfrom t he in fluence of the busin ess promotion

divisions, for example, by being indepen dent of th e

business pr omotion divisions and n ot havingdirectors concurr ently overseeing both th e screening

and m ana gement division an d the business

promotion divisions?

If the screening and ma na gement division is not

independen t of the busin ess promotion divisions or if

a director concurr ently oversees both th e screening

and m ana gement division an d the business

promotion divisions, ha s t he inst itut ion p rovided for

checking functions to ensur e tha t screening and

mana gement is appropriate?

(2) Role of screening an d man agementdivision

(2) Does the screening an d man agement divisionprovide appropriate screening an d ma nagement of

loan s, for example, by accurat ely measur ing the

borr owers finan cial position, th e use to which t he

funds will be put , and t he resour ces from which the

loan will be repaid, an d ut ilizing this informat ion t o

verify th e accuracy of credit r at ings?

Does the screening and ma na gement division etc.

check that business promotion divisions ar eappr opriately following its inst ructions, tha t th ey

ha ve soun d lending st an ces (providing a smooth flow

of funding t o borr owers en gaged in sound

businesses, especially medium, sma ll, an d micro

businesses etc., banning speculative real estate

lending a nd lending for excessively speculative

fina ncial schemes, and refusing to supply funds t o

ant isocial elements), and t hat they ar e not engaged

in in appr opriate collections of fund s?


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Does the screening and ma na gement division

commu nicate t o business promotion divisions t hat

the Financial Inspection Manuals created by th e

aut horities ar e not t o be used as an excuse for

refusing to lend t o borr owers enga ged in sound

businesses, for recalling funds from su ch borrowers,

or for oth er ina ppropriat e han dling? Does it check to

ensure that the business promotion divisions are not

engaged in inappropriate ha ndling?

3. Credit management (1) Esta blishment of credit mana gementdivision

(1) Do the business p romotion divisions a nd screeningand m an agement division have systems in place for

integra ted ma nagemen t of credits (for example, th esta tu s of business conditions in th e borrowers

industry) that covers, to the extent permitt ed under

applicable laws an d ordinan ces, the financial

instit ut ion, its consolidated subsidiar ies, an d its

subsidiaries falling under the equity method?

Is a s pecific division a ssigned t o verify th e levels of

write-offs an d r eserves? Does th is division very t ha t

th e levels of write-offs an d reser ves ar e

commensu ra te to credit risks, and does it report the

amoun t of write-offs and reser ves accura tely to theboard of directors?

Is a specific division a ssigned t o man age port folio

sta tu s (including the concent rat ion of lending in

specific indust ries a nd groups)? Does this division

engage in a ppropriate portfolio mana gement an d

does it r eport regula rly on the st at us of th e portfolio

to th e board of directors?

(2) Roles of credit auditing division (2) Does the inst itut ion ha ve a credit audit ing divisionth at ver ifies the accuracy of credit r at ings, thestat us of borrower credit ma nagement, an d other

relevant informa tion? Does th is division verify th e

appropriateness of credit ma nagement and report its

findings t o the board of directors etc? If a business

promotion division or a screening and m ana gement

division ma na ges th e portfolio, does the credit

aud iting division verify the ap propriat eness of

portfolio man agement ?


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Do financial institutions calculating their capital

adequacy ratios according to the Basle standards

have specialized systems for their crediting auditing

(including systems in which the risk management

division performs credit a udits)?

It would also be desirable for financial institutions

calculat ing their capita l adequacy rat ios according to

domestic standards to have specialized systems for

th eir credit auditin g divisions.

(3) Roles of r isk ma na gemen t division (3) Does the institut ion ha ve a risk mana gementdivision tha t provides integrated ma nagement of

asset s with credit r isk exposur e and off-balan ce-

sheet it ems? Does it pra ctice integra ted credit risk

management?

Do financial institutions calculating their capital


have specialized systems for their risk management

division (including systems in which the risk

man agement division performs credit au dits)?

It would also be desirable for financial institutions

calculat ing their capita l adequacy rat ios according todomestic standards to have specialized systems for

their risk man agement divisions.

4. Management of problem credi ts (1) Esta blishment of mana gement systemfor problem credits

(1) Is th ere a specific division assigned to man age an dcollect problem credits? Does it appr opriately

manage problem credits?

Does th e institu tion specify the ra nge of credits t hat

part icularly require man agement a s problem

credits?

Do fina ncial institu tions calculatin g their capital


ha ve specialized divisions for man aging an d

collecting problem credits? It would also be desira ble

for financial institu tions calculatin g their capital

adequa cy ra tios according to domestic sta nda rds t o

ha ve specialized systems for mana ging and

collecting problem credits.


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(2) Role of problem credit ma na gementdivision

(2) Does th e division responsible for man aging an dcollecting pr oblem credits a rt iculat e clear guidelines

for working with problem borrowers an d man age th e

business conditions etc. at problem borrowers

accordingly?

Are problem borrowers given appropriat e guidan ce

in rebu ilding, or ar e th ey liquidat ed or collected,

based on t he guidelines for working with p roblem

borrowers?

5. Self-assessment s on assetquality

See Credit Risk In spection Man ual.

6. Wr it e-offs a nd r eser ves See Cr ed it Risk In sp ect ion Ma nu al.


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3. Secur ities appr aisa l ............................................. 56(1) Bond app ra isal ..................................................... 56(2) Equ ity app ra isal ................................................. 56(3) Foreign securit y app ra isal ................................... 57(4) Securities investment trust beneficiary certificate

app ra isa l..................................................................... 57

4. Appra isal of othe r asset s ..................................... 57(1) Suspens e paymen t appr aisal ............................... 57(2) Chat tel and rea l esta te appr aisal ........................ 57(3) Golf club member ship a ppr ais al .......................... 58(4) Miscellaneous assets appr aisa l ........................... 58

Inspections of capital a dequacy ra tiosI. Inspections of the accuracy of capital a dequacy

ra tios .................................................................... 59

II . Verificat ion of th e effect of write -off an d res erveinspection results on capital a dequacy ratios.. . .. . 59

1. Stu dy write-off an d reser ve levels ...................... 602. Calculation of additional requ ired writ e-off andres erve valu es ...................................................... 60

III. Monitoring of th e financial inst itut ions response t odeclines in th e capit al adequa cy ra tio ................. 60


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(3) Other a ssets tha t the chief inspector specifically designates for sampling:

Are designated as classified assets.

However, when t he financial institut ion u nder inspection ha s esta blished a sam pling exclusion t hresh old below which credits ar e not

sam pled, these credits sh all be excluded if the t hresh old is deemed r at ional in light of a genera l evaluation of the institu tions a sset size an d

nat ure, a nd t he influence on write-offs a nd r eserves etc.


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ItemItemItemItem Verificat ion of the appropr ia teness of self-Verificat ion of th e a ppropriat eness of self-Verification of the a ppropria teness of self-Verificat ion of th e a ppropriat eness of self-

assessment sta ndardsassessment standardsassessment sta ndardsassessment standards

Verification of th e app ropriat eness of self-assessmentVerification of th e ap propriat eness of self-assessmentVerification of th e app ropriat eness of self-assessmentVerification of th e ap propriat eness of self-assessment

resultsresultsresultsresults

RemarksRemarksRemarksRemarks

t i t )


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corporat ions etc.)

C. Special bonds (issued by pu bliccorporat ions or compan ies in wh ich

the government has invested but n ot

government-guaranteed).

D. Bank debentu resE . All bonds from issuin g compan ies th at

ha ve been ra ted BBB (triple B) or

better in th eir most recent rat ing by a

rat ings agency.

F . All indust rial bonds issued bycompa nies issu ing exchange-listed

indust rial bonds; all bonds selected for

over-the-count er pr ice quota tions.However, th e bonds described in E a nd

F sh all be classified if a study of the

financial position of th e issuer or the n atu re

of the industrial bond based on the sa me

concepts a s for credits indicates pr oblems

with safety.

2)2)2)2) Bond classification met hodBond classification met hodBond classification met hodBon d cla ssifica tion met hod A. Stu dy the finan cial position of th eissuers of all bonds except those listed

in A-F in 1) above using th e sam e

concepts a s for credits. If the s tud y

reveals no particular pr oblems with

safety, or if ther e is a su perior

guara ntee from a financial institution

etc., treat th e bond as n on-classified.

B. The book valu e of bonds described inth e proviso to 1) above an d bonds

other t han as described in A above is

assigned to Category II; the estimat edloss for bonds likely to generate losses

is assigned t o Category IV.

Note that privately-placed

bonds ar e categorized according to th e

degr ee of risk of loss of valu e usin g th e

sam e meth od as for credits.

If the institut ion does not ha ve

credits a gainst th e issuer of the bond,

it ma y categorize th e bond a ccordingto simplified criteria .

Verify tha t t he estimat ed loss ha s been assigned to

Cat egory IV for bonds issued by part ies with borrower

classifications of effectively bankrupt or bankrupt.

Verify th at privat ely-placed bonds a re cat egorized

using the sam e methods as credits.


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Item Verifica t ion of the appropriateness of self-

assessment standards

Verification of th e ap propriat eness of self-assessment

results

Remarks

(3) Golf club memberships Assign to Category II except for those Verify th at golf club member ships a re cat egorized


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(3) Golf club memberships Assign to Category II except for thoseheld for welfar e pur poses.

However, when th ere ar e deemed to be

problems in th e financial position of th e

issuer of the m embersh ip, assign aborrower classification u sing th e sam e

concepts a s for credits regar dless of th e

pur pose for which th e membersh ip is held.

Assign t hose classified as needs at ten tion

or in da nger of bankr upt cy to Cat egory II;

those classified as effectively bankrupt or

ban kru pt for which th e facilities can s till

be used a s Cat egory II; and those for wh ich

th e facilities cannot be u sed as Ca tegory IV.

When golf club mem berships a re h eldnot as other a ssets but on secur ities

accounts, use appropriate securities

meth ods for their categorization.

If th e institu tion does not have credits

against t he issuer of the membership, it

may u se simplified criter ia in

categorization.

Verify th at golf club member ships a re cat egorized

as described left.

When membersh ips are held on secur ities accounts,verify th at th ey are categorized as described left.

(4) Miscellaneous asset s Ca tegor ize assets other than thoseabove according to t heir collection r isk a nddegr ee of risk of loss of valu e in light of th e

nat ure of the asset.

Verify tha t miscellaneous assets a re categorized asdescribed left.

A. For pur chasing credits issued by non-fina ncialinstitution tha t a re deemed to be long-term credits

because of cont inuin g purchases at set a mounts ,

verify th at the pu rchasin g credit is categorized

using th e same meth ods as for credits.

Note that banks th at h ave established

special transaction accounts and use those

account s to purchase on a cont inua l basispur chasing credits issued by non-finan cial

instit ut ion so as to be deemed to be providing long-

ter m credits, have ina ccura tely cat egorized the

credit and also inaccurately calculated their capital

adequa cy ra tio, an d ar e fur ther more in violat ion of

Article 17-10 (ban on inter -accoun t t ra nsfers) of the

Concomitant Orders t o th e Bankin g Law (Law No.

10 of 1982). Verify tha t t his has n ot ta ken place.

B. When the financial institution under inspectionuses tr ust schemes to liquidate credits, and th efina ncial institu tion under inspection holds

Item Verifica t ion of the appropriateness of self-

assessment standards

Verification of th e ap propriat eness of self-assessment

results

Remarks

beneficiary certificat es in th e loan credit tr ust

h if h h l di


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scheme, verify tha t these loan credit tru st

beneficiary cert ificat es ar e categorized using t he

same meth ods as credits.


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Item Verifica t ion of the appropriateness of write-

off and reserve stan dards

Verificat ion of th e ap propriat eness of write-off an d

reserve results

Remarks

avera ge loss percent age for 1 -

forecast collection rate.

post as default r eserves the expected loss amount

calculated u sing the default r ate-based method.


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3) Verificat ion of exclusion of abn orma l valuesIf the institu tion excludes losses or

ban kru ptcies associat ed with specific borrowers

from its default rat es and/or ban kruptcy

probabilities becau se these values a re abnorma l,

verify th at ther e is rational justificat ion for th e

exclusion.

Specifically, if th e in stitu tion excludes

losses and ban kru ptcies associated with specific

borrowers from calculations of defau lt r at es an d/or

ban kru ptcy probabilities as abnormal values by

claiming that th e borr ower should have been

classified as in danger of bank rupt cy but wasinstea d classified as norma l or needs a tt ention,

verify that the losses and ban kruptcies are

reflected in calculat ions of defau lt r eserves in some

form, for example, by including t hem in

calculat ions of expected loss a mount for credits t o

in da nger of bank ru ptcy borrowers.

Verify whet her t he instit ution excludes as

abnorma l values losses and/or ba nkr upt cies

associat ed with specific indust ries a nd/or locat ions

by claiming that there a re sha rp differencesbetween losses an d bank ruptcies in t hese

indust ries an d/or locat ions an d losses and /or

bankruptcies in other industries and/or locations.

In t hese cases it is not appropriat e to exclude

losses an d/or ba nkr upt cies to specific industr ies

an d/or locations as abnormal. Rat her, it is

desirable that the institu tion group credits by

indust ry and /or location, calculate default r at es

an d/or ban kru ptcy probabilities for ea ch group,

find expected loss rat es for ea ch, and calculateexpected loss amoun ts a s the credits t o each group

mult iplied by the expected loss ra te for t he group.

4) Verification of calculation per iod for default ra tesand bankru ptcy probabilities

Verify that calculations of expected loss

amounts a re based at t he very least on default

rat es and bankru ptcy probabilities for the

preceding thr ee calculat ion periods.

If the calculat ion period is not t hree pa st


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Study t he appr opriat eness of this r esponse, verify what the capita l adequacy ratio will be in the n ext settlement term as a result of provisions of

additional required wr ite-offs and reserves a s called for in a ppropriate r esponse plan s, an d endeavor to form a consensu s a mong the chief inspector, th e

fina ncial institu tion under inspection an d the externa l auditors.

In a ddition, verify whether t he capital adequacy ratio this settlemen t t erm a nd next set tlement term could be at levels tha t would invoke Prompt

C ti A ti t f th i A ti l 21 2 t f th C it t O d t th B ki L (1982 Mi i t f Fi O di )


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Corrective Actions a s set forth in Article 21-2 etc. of the Concomit an t Or ders t o th e Ban king Law (1982 Ministr y of Finan ce Ordinan ce).

In doing this, verify whet her th e instit ut ion falls un der t he pr ovisions of Article 21-3:2 or 3 of th e Concomit an t Or ders .

Credit Risk Credit Risk Credit Risk Credit Risk Management 1866

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