General Guidance for Developing Differential Premium Systems

October 31, 2011
It is important to understand that even when it is decided that conditions
are appropriate to introduce differential premiums, such systems are most
effective at achieving their objectives when they provide good incentives for
banks to manage their risks and when they are accompanied by effective
early warning systems and prompt corrective supervisory action to deal
with problem banks.
IV. Approaches used to differentiate bank risk
One of the most challenging aspects of developing a differential premium
system is finding appropriate methods for differentiating among the risk
profiles of banks. A number of approaches are available and in general they
encompass methodologies which emphasize mainly objective or quantitative
factors and/or those which rely on more subjective or qualitative information.
Although difficult to accomplish, the approach used to differentiate risk and
assign premiums should be as forward looking as possible.
The following section describes some of the most commonly used criteria or
factors for differentiating the risk profiles of banks for premium assessment
purposes and some of the advantages, disadvantages and trade-offs
associated with their use.
a) Quantitative Criteria Approaches
Quantitative criteria approaches generally try to use measures that are
factual or data driven to categorize banks for premium assessment purposes.
Some quantitative systems rely on only one factor to assess risk while others
combine a number of factors. Information is usually gathered through onsite
or off-site data collection and supervisory processes. Factors that are
commonly considered for such systems usually include:
a bank’s adherence with regulatory capital requirements or other
measures of the quantity, quality and sufficiency of a bank’s capital;
the quality and diversification of a bank’s asset portfolio both on- and
off-balance sheet;
the sufficiency, volatility and quality of a bank’s earnings;
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