2013 - ICC India

68ICC BANKING COMMISSION | 2013 GLOBAL RISKS TRADE FINANCE | APPENDIX C89 “Economically, maturity adjustments may also be explained as a consequence of mark-tomarket(MtM) valuation of credits. Loans with high PDs have a lower market value today thanloans with low PDs with the same face value, as investors take into account the ExpectedLoss, as well as different risk-adjusted discount factors. The maturity effect would relateto potential down-grades and loss of market value of loans. Maturity effects are strongerwith low PDs than high PDs: intuition tells that low PD borrowers have, so to speak, more“potential” and more room for down-gradings than high PD borrowers. Consistent withthese considerations, the Basel maturity adjustments are a function of both maturity and PD,and they are higher (in relative terms) for low PD than for high PD borrowers” BCBS (2005)90 From this chart it can be seen that a 2.5 year effective maturity vs. using a 1 maturityincreases the RWAs by approximately 15% and 45% depending upon the underlyingcustomer rating. Likewise using an effective maturity of 0.25 years if permitted wouldreduce RWAs by up to approximately 25%91 “A significant innovation of the revised Framework is the greater use of assessments of riskprovided by banks’ internal systems as inputs to capital calculations. In taking this step,the Committee is also putting forward a detailed set of minimum requirements designed toensure the integrity of these internal risk assessments. … Each supervisor will develop a setof review procedures for ensuring that banks’ systems and controls are adequate to serveas the basis for the capital calculations. ... The Committee expects national supervisors willfocus on compliance with the minimum requirements as a means of ensuring the overallintegrity of a bank’s ability to provide prudential inputs to the capital calculations and not asan end in itself.” §6 BCBS (2006)92 See §452-7 BCBS (2006) for the specific rules93 For retail customers, Basel II allows banks to use a product level definition of default as incertain markets there is strong evidence that default on one product does not automaticallylead to default on all products.94 Given the limited number of trade finance defaults, and possible historical data collectionissues, not all firms will find it easy to demonstrate the low loss nature of the transactionsand hence may be unable to reflect the improved recovery within their LGD estimates.95 This is because the LGD would equal 50% x 0 + 50% x normal LGD.96 This is true for all products where repayment is expected despite a customer-level default.97 §4 BCBS (2006)98 §447 BCBS (2006)99 §397 BCBS (2006). This paragraph does allow for two exceptions: “Firstly, in the caseof country transfer risk, where a bank may assign different borrower grades dependingon whether the facility is denominated in local or foreign currency. Secondly, when thetreatment of associated guarantees to a facility may be reflected in an adjusted borrowergrade. In either case, separate exposures may result in multiple grades for the sameborrower.”100 Confirming banks adopting the Standardized approach may be allowed to use a preferentialrisk weight for the exposure to the issuing banks101 In our example above, the 100 customer defaulting in Q1 would have had only 1 LC each,those in Q2 would have had an L/C in Q1 and in Q2 etc. so that the average number of L/Csper default would be ~2 vs. 4 for non-defaults.102 For a given level of turnover, one might expect firms to require a similar number of L/Cs, andgiven lager firms have larger turnover, it may be reasonable to assume that all else beingequal they may use more L/Cs. Furthermore, larger firms might also be more likely to use aglobal supply chain (as opposed to a domestic supply chain), meaning they may be asked forL/Cs more frequently.103 From the Trade Register it is possible for some cases to calculate the number of tradefinance products held for customers where there was a write-off. The average number ofproducts for customers where there was a write-off was approximately 2.3, but we cannotunfortunately see this same information for non-defaulting customers.104 There are though for example requirements that “Irrespective of whether a bank isusing external, internal, or pooled data sources, or a combination of the three, for its PDestimation, the length of the underlying historical observation period used must be at leastfive years for at least one source. If the available observation period spans a longer periodfor any source, and this data are relevant and material, this longer period must be used.”§463 BCBS (2006)105 §11 UK FSA (2007b). The emphasis has been added here.106 Calderón, Fuentes (2010). It should be noted that there are a number of differentapproaches to dating economic cycles, and the results from this paper have been chosenas it covers a range of economies, rather than as an endorsement of one approach to cycledating or another.107 Unfortunately the authors do not include China because despite collecting data for Chinathey “could not register an output contraction within the sample period of our data”. Inaddition, this uses quarterly data whereas the Trade Register data is available on an annualbasis. As this calculation is provided for illustrative purposes only, these issues are notconsidered unduly problematic at this stage.