2013 - ICC India

24ICC BANKING COMMISSION | 2013 GLOBAL RISKS TRADE FINANCE | ANALYSIS OF SHORT-TERM PRODUCTSAs discussed in the appendix, Basel requires that the LGD is calculatedon the basis of the economic loss, i.e. the time value of money is includedwithin the calculation. Therefore, if it takes two years to recover money froma defaulted customer, this recovery should be discounted by an appropriatediscount rate for two years. There is some debate about the appropriatediscount rate to use and it is not our intention to state an opinion on themost appropriate discount rate. Instead we have used a figure of 9% 28 inthese results and discount reported recoveries for one or two years 29 .Basel also requires that the LGD for an exposure should include appropriatedirect and indirect costs for recovering an exposure. Naturally the costsincurred will vary from bank to bank and will also vary depending on thecomplexity of the underlying transaction. There are not many publishedstudies that discuss the level of costs, so we have used a figure of 2% ofthe defaulting exposure 30 . The table below adds in these two factors todetermine the LGD after discounting and costs.FIGURE 18Estimated economic loss rate as a percentage of defaultingexposure after discounting and costs, 2008-11AS % OF DEFAULTED AMOUNTRECOVERYRATE1 –RECOVERYRATEDISCOUNT ONRECOVERIES +COSTSDEFAULTEDTRANSACTIONECONOMIC LOSSImport L/Cs 71% 29% 13% 42%Export Confirmed L/Cs 40% 60% 7% 68%Loans for Import 45% 55% 9% 64%Loans for Export – Bank Risk 32% 68% 5% 73%Loans for Export – Corp. Risk 51% 49% 8% 57%Performance guarantees 18% 82% 3% 85%Total 52% 48% 9% 57%It should be noted that these figures are likely to overestimate the true LGDon these types of product. This is due to the prudent assumptions we havemade where data is missing (see appendix) and the difference between thisdefaulted transaction economic loss estimate and an LGD calculated basedon a customer definition of default as described below.3.4.1. Defaulted transaction economic loss rate vs. Basel LGDAs discussed in more detail in the appendix, Basel rules mean that firmsshould use a single PD for all exposures to a corporate customer. This meansthat even though the observed transaction default rate for short-term tradefinance products is approximately 0.021%, the PD used when calculating ELand RWAs for each transaction would be the customer PD. Assuming thatthis was on average the same as the observed one-year default rate for theMoody’s rated universe from 1983-2011, this would mean firms would applyan average customer PD of 1.69% 31 .