| 4.6.1 | EAD for an on-balance sheet or off-balance sheet item is defined as the expected gross exposure of the facility upon default of the obligor. For on-balance sheet items, banks should estimate EAD at no less than the current drawn amount, subject to recognizing the effects of on balance sheet netting as specified in the Foundation IRB Approach (see the ”Risk-Weighting Framework for IRB Approach”). The minimum requirements for the recognition of netting are the same as those under the Foundation IRB Approach.
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| 4.6.2 | The additional minimum requirements for internal estimation of EAD under the Advanced IRB Approach, therefore, focus on the estimation of EAD for off- balance sheet items (excluding derivatives). Banks using the Advanced IRB Approach should have established procedures in place for the estimation of EAD for off balance sheet items. These should specify the estimates of EAD to be used for each facility type. Banks’ estimates of EAD should reflect the possibility of additional drawings by the borrower up to and after the time a default event is triggered. Where estimates of EAD differ by facility type, the delineation of these facilities should be clear and unambiguous.
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| 4.6.3 | Banks using the Advanced IRB Approach should assign an estimate of EAD for each facility. It should be an estimate of the long run default-weighted average EAD for similar facilities and borrowers over a sufficiently long period of time, but with a margin of conservatism appropriate to the likely range of errors in the estimate.
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| 4.6.4 | If a positive correlation can reasonably be expected between the default frequency and the magnitude of EAD, the EAD estimate should incorporate a larger margin of conservatism. Moreover, for exposures for which EAD estimates are volatile over the economic cycle, banks should use EAD estimates that are appropriate for an economic downturn, if these are more conservative than the long run average.
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| 4.6.5 | For banks that have been able to develop their own EAD models, this could be achieved by considering the cyclical nature, if any, of the drivers of such models. Other banks may have sufficient internal data to examine the impact of previous recessions. However, some banks may only have the option of making conservative use of external data.
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| 4.6.6 | The criteria by which estimates of EAD are derived should be plausible and intuitive, and represent what banks believe to be the material drivers of EAD. The choices should be supported by banks’ credible internal analysis. Banks should be able to provide a breakdown of their EAD experience by the factors they see as the drivers of EAD. Banks should use all relevant and material information in their derivation of EAD estimates. Across facility types, banks should review their estimates of EAD when material new information comes to light and at least on an annual basis.
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| 4.6.7 | Due consideration must be paid by the bank to its specific policies and strategies adopted in respect of account monitoring and payment processing. The bank must also consider its ability and willingness to prevent further drawings in circumstances short of payment default, such as covenant violations or other technical default events. Banks must also have adequate systems and procedures in place to monitor facility amounts, current outstandings against committed lines and changes in outstandings per borrower and per grade. The bank must be able to monitor outstanding balances on a daily basis.
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| | 477(i). For transactions that expose banks to counterparty credit risk, estimates of EAD must fulfill the requirements set forth in Annex 4 of this Framework.
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| | (Refer para 477, International Convergence of Capital Measurement and Capital Standards – June 2006)
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| 4.6.8 | For corporate, sovereign, and bank exposures, estimates of EAD should be based on a time period that should ideally cover a complete economic cycle but should in any case be no shorter than a period of seven years. If the available observation period spans a longer period for any source, and the data are relevant, this longer period should be used. EAD estimates should be calculated using a default-weighted average and not a time weighted average.
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| 4.6.9 | For retail exposures, the minimum data observation period for EAD estimates is five years. The less data a bank, the more conservative it should be in its estimation. A bank need not give equal importance to historical data if it can demonstrate to SAMA that more recent data are a better predictor of draw-downs.
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| 4.6.10 | SAMA applies the transitional requirement of a minimum of two years of data at the time of adopting the IRB Approach for retail exposures to banks that can implement such an approach during the period from 1 January 2007 to 31 December 2009. This requirement will increase by one year for each of the three years after year-end 2009.
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