PIB 4 Part 2 PIB 4 Part 2 — Credit Risk Systems and Controls
PIB 4.2 PIB 4.2 Application of this part
This part applies to an
Authorised Firmin Category1, 2, 3A or 5 with respect to both its Non-Trading Bookand Trading Booktransactions.
PIB 4.3 PIB 4.3 Credit Risk Management Systems
PIB 4.3.1 PIB 4.3.1
Authorised Firmmust implement and maintain comprehensive Credit Riskmanagement systems which:(a) are appropriate to the firm's type, scope, complexity and scale of operations;(b) enable the firm to effectively identify, assess, monitor and control Credit Riskand to ensure that adequate Capital Resourcesare available to cover the risks assumed; and(c) ensure effective implementation of the Credit Riskstrategy and policy.
PIB 4.3.1 Guidance1.
Credit Riskis the risk that a borrower or Counterpartyfails to meet its obligations. It exists in both the Non-Trading Bookand the Trading Book, and both on and off the balance sheet of an Authorised Firm.2. Obviously, Credit Riskarises from loans but there are other sources of Credit Risksuch as.a. trade finance and acceptances;b. interbank transactions;c. commitments and guarantees;d. interest rate, foreign exchange and Credit Derivatives(including swaps, options, forward rate agreements and financial futures);e. bond and equity holdings; andf. settlement of transactions.3. The objective of the Credit Riskmanagement system must be to ensure that every Authorised Firmholds adequate capital to cover Credit Riskand absorb any potential losses arising from that risk. Since Authorised Firmsneed to provide credit as part of their usual business, this needs to be achieved by effectively managing the Credit Riskassumed by the Authorised Firmas part of its credit business.4. Failure to manage Credit Riskeffectively could cause an Authorised Firmto face a situation of inadequate capital, which would threaten its safety and soundness. Such problems normally arise from:a. lax credit standards for borrowers and Counterparties;b. poor portfolio risk management; andc. failure to identify in good time changes in economic or other conditions that may impair the financial strength of borrowers and Counterparties.5. Therefore, it is essential for Authorised Firmsinvolved in the business of providing credit to design, implement and maintain comprehensive and effective systems to manage Credit Risk.
Credit Riskmanagement framework of an Authorised Firmmust have at least the following principal elements effectively implemented to ensure that the Credit Risk Exposuresof the Authorised Firmare of a sufficiently good quality:(a) an appropriate Credit Riskenvironment, defined by a documented Credit Riskstrategy and a documented Credit Riskpolicy;(b) application of the Credit Riskstrategy and policy, where appropriate, on a consolidated basis and at the level of individual subsidiaries;(c) sound processes for assuming and managing Credit Risk;(d) prudent lending controls and limits, including policies and processes for monitoring Exposuresin relation to limits, and approvals of exceptions to limits;(e) adequate appropriately skilled human resources to manage the Credit Riskfunction;(f) independence of credit approval and review functions from credit initiation functions to avoid any real or potential conflicts of interest;(g) prudent procedures for approving credits, defined by a documented credit procedures manual;(h) effective systems for credit administration, measurement and monitoring; and(i) adequate controls over Credit Risk.
PIB 4.3.3 PIB 4.3.3(1) An
Authorised Firmmust ensure that its Governing Bodyretains responsibility for the Credit Riskmanagement framework and ensure it is appropriate for the nature, scale and complexity of operations, in the context of prevailing market and macro-economic conditions.(2) An Authorised Firmmust ensure that its senior management or an appropriate designated body, regularly reviews and understands the implications as well as the limitations of the risk management information that they receive from the Credit Riskmanagement function, in order to evaluate the suitability and effectiveness of such information in enabling them to provide effective oversight over the Credit Riskmanagement function.(3) An Authorised Firmmust ensure that its Governing Bodyregularly reviews and understands the implications as well as the limitations of Credit Riskmanagement information and reports presented to it, to ensure that the contents and the format of such reports are suitable for effective Governing Bodyoversight.(4) An Authorised Firmmust ensure that its Governing Bodyis responsible for carrying out regular stress testing on the credit portfolio which is appropriate for the nature, scale and complexity of the Credit Risksassumed by the Authorised Firm. An Authorised Firmmust ensure that its Governing Bodyannually reviews the stress scenarios and takes action to address any perceived issues arising from those reviews.(5) An Authorised Firmmust establish and enforce internal controls and practices so that deviations from policies, procedures, limits and prudential guidelines are promptly reported to the appropriate level of management.
PIB 4.3.3 Guidance1. An
Authorised Firmmay structure its credit processes and Credit Riskmanagement function in a manner which suits its or its Group'sinternal organisational structure, culture and internal practices, provided the key functions and components relevant to Credit Riskmanagement, as mentioned above, are present, and there must be adequate segregation of functions responsible for critical Credit Riskmanagement processes. In particular, the credit initiation function must be independent of the credit approval and review functions to avoid any potential conflicts of interest. In cases where an Authorised Firmfinds it necessary to delegate small lending limits to staff in the front office for operational needs, there must be adequate safeguards, e.g. independent review of credits granted, to prevent abuse.2. An Authorised Firm'ssenior management or an appropriately delegated body (such as a credit committee) should be responsible for effectively implementing the Credit Riskstrategy and policy approved by the Governing Bodyof the Authorised Firm. Senior management or such a credit committee will need to establish adequate procedures to identify, quantify, monitor and control the Credit Riskinherent in the Authorised Firm'sactivities and at the level of both the overall portfolio and individual borrowers/ Counterparties.3. The appropriate level at which credit decisions are taken will vary according to the type of credit offered and the size and structure of the Authorised Firm. For some Authorised Firms, a credit committee may be appropriate, with formal terms of reference laid down. In other Authorised Firms, individuals may be given pre-assigned authority limits. It will usually be appropriate for the final credit approval authority to be given by staff reporting independently from those staff interacting with clients.4. As part of its stress testing programme for Credit Riskmeasurement, an Authorised Firmshould take into account the realistic recoveries available from security or Collateralunder stressed market and macro-economic conditions.5. PIB Rule 4.3.3 (3) requires the Governing Bodyof an Authorised Firmto review the management information reports presented to it by the senior management of that firm and assess the reports in respect of their utility and effectiveness in enabling the Governing Bodyto effectively discharge their responsibilities towards effective oversight of the firm and its credit risk management.
PIB 4.3.4 PIB 4.3.4
Authorised Firmmust also consider whether it is prudent to set out specific provisioning requirements for country and transfer risks to which it is exposed.
PIB 4.3.5 PIB 4.3.5
Authorised Firmavails itself of Credit Riskmitigations, the Authorised Firmmust have mechanisms in place to regularly assess the net realisable value of such mitigations taking into account prevailing market conditions.
PIB 4.3.5 Guidance1. PIB section 4.13 sets out the principles and methodologies for the recognition of
Credit Riskmitigation in the calculation of Credit RWA.2. Further Guidanceon Credit Risksystems and controls (including Credit Riskmitigation), and on the specific areas which the Credit Riskpolicy should cover, is set out in PIB section A4.1.
PIB 4.4 PIB 4.4 Credit Risk Strategy, Policy, and Procedures Manual
Credit Risk Strategy
PIB 4.4.1 PIB 4.4.1(1) An
Authorised Firmmust implement and maintain a Credit Riskstrategy, which prescribes its stated degree of risk tolerance, level of capital available for credit activities, business strategy for credit activities and Credit Riskmanagement approach.(2) The strategy must be:(a) documented;(b) approved by the Governing Body; and(c) regularly reviewed and updated by the Authorised Firmat periodic intervals and at least annually, as appropriate to the nature, scale and complexity of its activities.
PIB 4.4.1 Guidance1. An
Authorised Firm's Credit Riskstrategy should reflect the aim to achieve sound credit quality while ensuring profit and business growth. Therefore the Credit Riskstrategy should address the Authorised Firm'sapproach towards the decision on an acceptable level of risk/reward relationship, after taking into account resource and capital costs.2. An Authorised Firm's Credit Riskstrategy should allow for economic cycles and their effects on the credit portfolio during different stages of an economic cycle. For example, it should cater for a higher incidence of defaults in the personal loan and credit card portfolios in times of economic recession.
Credit Risk Policy
PIB 4.4.2(1) An
Authorised Firmmust implement and maintain a Credit Riskpolicy which prescribes all the essential elements of the Credit Riskmanagement system and associated processes.(2) The policy must be:(a) documented;(b) approved by the Governing Body; and(c) regularly reviewed and updated by the Authorised Firmat periodic intervals and at least annually, as appropriate to the firm's current financial performance, credit market conditions in its main markets and its Capital Resourcesposition as well the firm's nature, scale and complexity of its activities.(3) Any changes to the Credit Riskpolicy and how exceptions to the policy will be dealt with must be approved by the Governing Bodyor an appropriately delegated committee of senior management (such as a credit committee).(4) An Authorised Firmwith one or more branches outside the DIFCmust implement and maintain Credit Riskpolicies adapted to each local market and its regulatory conditions.
Credit Riskpolicy must:(a) be consistent with the approved Credit Riskstrategy, considering a range of factors, including but not limited to an approved degree of risk tolerance, capital allocated to Credit Risks, business strategy and market conditions in its main credit markets;(b) provide sound, well-defined Credit Risknorms and criteria for approval of credit applications;(c) clearly specify the Exposurelimits, product types, business segments, nature of target borrowers and the nature of Credit Riskthat the Authorised Firmwishes to incur;(d) set out, where appropriate, the amounts and terms and conditions under which Counterpartiesor clients may be eligible or ineligible for credit;(e) include minimum information that is required to be obtained for processing an application for credit;(f) include well defined criteria and policies for approving new Exposuresas well as renewing and refinancing existing Exposures, identifying the appropriate approval authority for the size and complexity of the Exposures;(g) include effective credit administration policies, including continued analysis of a borrower's ability and willingness to repay under the terms of the debt, monitoring of documentation, legal covenants, contractual requirements and Collateral, and a classification system that is consistent with the nature, size and complexity of the Authorised Firm'sactivities or, at the least, with the asset grading system prescribed in PIB Rule 4.5.4;(h) include comprehensive policies for reporting Exposureson an on-going basis;(i) include comprehensive policies for identifying and managing problem assets;(j) include a provisioning policy approved by the Governing Bodywhich ensures that all loans are promptly and prudently provided for;(k) set out limits and approval processes involved for the approval of credit facilities that can be approved by the delegated authorities, and stipulate that the Governing Bodyretains responsibility for the governance of such limits;(l) require that major Credit Risk Exposuresexceeding a specified amount or at a minimum all Large Exposuresof the Authorised Firmare approved by the Authorised Firm'ssenior management or its designated body like credit committee; and(m) require that all Credit Risk Exposuresthat are especially risky or inconsistent with the approved credit strategy of the Authorised Firmare approved by the Authorised Firm'ssenior management or its designated body such as a credit committee.
In relation to conflicts of interest and
Related Persontransactions, the policy must:(a) set out adequate procedures for handling conflicts of interest relating to the provision and management of credit, including measures to prevent any Persondirectly or indirectly benefiting from the credit being part of the process of granting or managing the credit;(b) subject to PIB Rule 4.4.5, prohibit Exposuresto Related Personson terms that are more favourable than those available to Personswho are not Related Persons; and(c) if Exposuresto Related Personsare allowed on terms which are no more favourable than those available to Personswho are not Related Persons, set out procedures that:(i) require such Exposures, and any write-off of such Exposures, exceeding specific amounts or otherwise posing special risks to the Authorised Firm, to be made subject to the prior written approval of the firm's Governing Bodyor the Governing Body'sdelegate; and(ii) exclude Personsdirectly or indirectly benefiting from the grant or write off of such Exposuresbeing part of the approval process.
PIB 4.4.5 PIB 4.4.5
The prohibition in PIB Rule 4.4.4(b) does not apply to providing credit to a
Related Personunder a credit policy on terms (such as for credit assessment, tenor, interest rates, amortisation schedules and requirements for Collateral) that are more favourable than those on which it provides credit to Personswho are not Related Persons, provided the credit policy:(a) is an Employeecredit policy that is widely available to Employeesof the Authorised Firm;(b) is approved by the Authorised Firm's Governing Bodyor the Governing Body'sdelegate;(c) clearly sets out the terms, conditions and limits (both at individual and aggregate levels) on which credit is to be provided to such Employees; and(d) requires adequate mechanisms to ensure on-going compliance with the terms and conditions of that credit policy, including immediate reporting to the Governing Bodyor the Governing Body'sdelegate where there is a deviation from or a breach of the terms and conditions or procedures applicable to the provision of such credit for timely and appropriate action.
PIB 4.4.5 Guidance1. The requirements in these
Rulesdo not prevent arrangements such as Employeeloan schemes that allow more favourable and flexible loan terms to Employeesof the Authorised Firmthan those available under its normal commercial arrangements. However, such a loan scheme must comply with the requirements set out in these Rules, which are designed to address conflicts of interest that may arise in the grant, approval or management of such loans. Such conflicts are especially likely to arise where one or more of the Employeesconcerned are Directors, Partnersor senior managers.2. Generally, where an Authorised Firmhas an Employeeloan scheme under these Rules, the DFSAexpects its Governing Bodyto have ensured, before it or its delegate approved that scheme, that the terms, conditions and particularly limits (both at individual and aggregate level) on which credit is to be provided to Employeesunder the scheme are adequate and effective in addressing the risks arising from such lending. The Authorised Firmshould also be able to demonstrate to the DFSAthat the procedures it has adopted relating to an Employeeloan scheme are adequate to address any risks arising from such lending. The DFSAexpects to have access to records relating to lending under an Employeeloan scheme upon request or during its supervisory visits. Any significant breach of or deviation from the procedures adopted in relation to an Employeeloan scheme may also trigger the reporting requirements to the DFSAunder GEN Rule 11.10.7.
For the purposes of the
Rulesin this chapter, a Personis a " Related Person" of an Authorised Firmif the Person:(a) is, or was in the past 2 years:(i) a member of a Groupor Partnershipin which the Authorised Firmis or was also a member; or(ii) a Controllerof the Authorised Firmor a Close Relativeof such a Controller;(b) is, or was in the past 2 years, a Director, Partneror senior manager of the Authorised Firmor an entity referred to under (a)(i) or (ii), or a Close Relativeof such a Director, Partneror senior manager; or(c) is an entity in which a Director, Partneror senior manager of the Authorised Firmor an entity referred to in (a)(i) or (a)(ii), or a Close Relativeof such a Director, Partneror senior manager has a significant interest by:(i) holding 20% or more of the shares of that entity, or a Parentof that entity, if that entity is a company; or(ii) being entitled to exercise 20% or more of the voting rights in respect of that entity;except that a Partneris not a Related Personwhere that Personis a limited partner of a Limited Partnershipformed under the Limited PartnershipLaw of 2006 or any similar limited partnership constituted under the law of a country or territory outside the DIFC.
Credit Procedures Manual
Authorised Firmmust implement and maintain a documented credit procedures manual, which sets out the criteria and procedures for granting new credits, for approving extensions of existing credits and exceptions, for conducting periodic and independent reviews of credits granted and for maintaining the records for credits granted.
PIB 4.4.8 PIB 4.4.8
The credit procedures manual must establish:(a) sound, well-defined criteria for granting credit, including a thorough understanding of the borrower or
Counterparty, the purpose and structure of the credit and its source of repayment;(b) well defined processes for approving new Exposuresas well as renewing and refinancing existing Exposures;(c) effective credit administration processes, including continued analysis of a borrower's ability and willingness to repay under the terms of the debt, monitoring of documentation, legal covenants, contractual requirements and Collateral;(d) effective processes for classification and grading of credit assets consistent with the nature, size and complexity of the Authorised Firm'sactivities;(e) comprehensive processes for reporting Exposureson an ongoing basis; and(f) comprehensive processes for identifying problem assets, managing problem assets, monitoring their collections and for estimating required level of provisions.
PIB 4.4.8 Guidance
The same criteria should be applied to both advised and unadvised facilities and should deal with all
Credit Risksassociated with the Authorised Firm'sbusiness whether in the Non-Trading or Trading Bookor on or off balance sheet.
PIB 4.5 PIB 4.5 Processes for Credit Assessment
PIB 4.5.1 PIB 4.5.1(1) When utilising external credit rating agencies as part of its credit assessment processes, an
Authorised Firmmust:(a) maintain an internal credit grading system; and(b) stress test its capital position on at least an annual basis to consider the capital implications to the Authorised Firmof a significant reduction in the credit quality and associated reduction on credit ratings from credit rating agencies for its credit portfolio.(2) An Authorised Firmmust not solely use external credit rating agency credit ratings as a basis for its assessment of the risks associated with an Exposure, in particular in respect of a Large Exposure, and must at all times conduct its own credit assessment of such an Exposure.
PIB 4.5.1 Guidance
Authorised Firmshould closely monitor the adequacy of the internal credit assessment processes, in order to assess whether there is an upward bias in internal ratings.
Authorised Firmmust implement and maintain appropriate policies, processes, systems and controls to:(a) administer its credit portfolios, including keeping the credit files current, getting up-to-date financial information on borrowers and other Counterparties, funds transfer, and electronic storage of important documents;(b) ensure that the valuations of Credit Riskmitigants employed by the Authorised Firmare up-to-date, including periodic assessment of Credit Riskmitigants such as guarantees and Collateral;(c) review all material concentrations in its credit portfolio and report the findings of such reviews to the Governing Body; and(d) measure Credit Risk(including to measure Credit Riskof off-balance sheet products such as Derivativesin credit equivalent terms) and monitor the condition of individual credits to facilitate identification of problem credits and to determine the adequacy of provisions and reserves.
PIB 4.5.3 PIB 4.5.3
Credit Riskmanagement system and, in particular, the systems, policies and processes aimed at classification of credits, monitoring and identification of problem credits, management of problem credits and provisioning for them must include all the on-balance sheet and off-balance sheet credit Exposuresof the Authorised Firm.
PIB 4.5.3 Guidance
Authorised Firmshould ensure that its loan portfolio is properly classified and has an effective early-warning system for problem loans.
PIB 4.5.4 PIB 4.5.4(1) An
Authorised Firmmust establish clearly defined criteria for identifying its problem credits and/or impaired assets which ensure that credits are classified as impaired in all cases where there is some reason to believe that all amounts due (including principal and interest) will, or may, not be collected in accordance with the contractual terms of the loan agreement.(2) For the purpose of (1), and subject to (3), an Authorised Firmmust categorise its credits into five categories as detailed in the following table, where credits in the substandard, doubtful and loss categories must be considered as problem credits:
Standard includes credits with no element of uncertainty about timely repayment of the outstanding amounts, including principal and interest. Credits are currently in regular payment status with prompt payments. Special mention includes credits with deteriorating or potentially deteriorating credit quality which, may adversely affect the borrower's ability to make scheduled payments on time. The credits in this category warrant close attention by the Authorised Firm. Substandard includes credits which exhibit definitive deterioration in credit quality and impaired debt servicing capacity of the borrower. Doubtful includes credits which show strong credit quality deterioration, worse than those in substandard category, to the extent that the prospect of full recovery of all the outstanding amounts from the credit is questionable and consequently the probability of a credit loss is high, though the exact amount of loss cannot be determined yet. Loss includes credits which are assessed as uncollectable and credits with very low potential for recoverability of amounts due.(3) An Authorised Firmmay also have in place a more detailed credit grading system provided it can address the categories detailed in (2).
PIB 4.5.4 Guidance1. With respect to the ratings above,
Authorised Firmsshould consider Exposuresas classified special mention, substandard, doubtful and loss where the loans are contractually in arrears for a minimum number of days of 30, 60, 90-120 and 120-180 days respectively. Authorised Firmsshould also consider the treatments as set out in PIB Rule 4.5.7 (Evergreening).2. Credits exhibiting the following categories should be included in the special mention category.(a) a declining trend in the operations of the borrower or in the borrower's ability to continue to generate cash required for repayment of the credit;(b) any signals which indicate a potential weakness in the financial position of the borrower, but not to the point at which repayment capacity is definitely impaired; or(c) business, economic or market conditions that may unfavourably affect the profitability and business of the borrower in the near to medium term.3. Credits exhibiting the following categories should be included in the substandard category.(a) inability of the borrower to meet contractual repayment terms of the credit facility;(b) unfavourable economic and market conditions or operating problems that would affect the profitability and cash flow generation of the borrower;(c) weak financial condition or the inability of the borrower to generate sufficient cash flow to service the payments.;(d) difficulties experienced by the borrower in servicing its other debt obligations; or(e) breach of any financial covenants by the borrower.
Authorised Firmmust have detailed policies, processes and resources for managing problem credits which address the following:(a) monitoring of credits and early identification of credit quality deterioration;(b) review of classification of problem credits; and(c) ongoing oversight of problem credits, and for collecting on past due obligations.
Authorised Firmmust ensure that each and every credit which qualifies as a Large Exposureand is classified as an impaired credit is managed individually. This includes valuation, classification and provisioning for such credits on an individual item basis.
Any evergreening exercise involving refinancing of past due credits must not result in their being classified as a higher category. In particular, impaired credits cannot be refinanced with the aim of classifying them as standard or special mention credits.
Authorised Firm'sprovisioning policy must specify the following minimum provisioning requirements:(a) for substandard assets — 20% of the unsecured portion of the credit;(b) for doubtful assets — 50% of the unsecured portion of the credit; and(c) for loss assets — 100% of the unsecured portion of the credit.
Authorised Firmmust, on a periodic basis, at a minimum monthly frequency, review its problem credits (at an individual level or at a portfolio level for credits with homogeneous characteristics) and review the asset classification, provisioning and write-offs for each of those problem credits.