| 4.5.1 | Banks should estimate an LGD for each facility that aims to reflect economic downturn conditions where necessary to capture the relevant risks. This LGD cannot be less than the long run default-weighted average loss rate given default calculated based on the average economic loss of all observed defaults within the data source for that type of facility. In addition, a bank should take into account the potential for the LGD of the facility to be higher than the default-weighted average during a period when credit losses are substantially higher than average.
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| | In all cases, both the borrower and all recognized guarantors must be assigned a borrower rating at the outset and on an ongoing basis. A bank must follow all minimum requirements for assigning borrower ratings set out in this document, including the regular monitoring of the guarantor’s condition and ability and willingness to honor its obligations.
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| | Consistent with the requirements in paragraphs 430 and 431, International Convergence of Capital Measurement and Capital Standards – June 2006, a bank must retain all relevant information on the borrower absent the guarantee and the guarantor. In the case of retail guarantees, these requirements also apply to the assignment of an exposure to a pool, and the estimation of PD.
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| | (Refer para 481, International Convergence of Capital Measurement and Capital Standards – June 2006)
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| 4.5.2 | For certain types of exposures, loss severities may not exhibit such cyclical variability and LGD estimates may not differ materially (or possibly at all) from the long run defaulted-weighted average. However, for other exposures, this cyclical variability in loss severities may be important and bank will need to incorporate it into their LGD estimates. For this purpose, banks may use averages of loss severities observed during periods of high credit losses, forecasts based on appropriately conservative assumptions, or other similar methods. Appropriate estimates of LGD during periods of high credit losses might be formed using either internal and/or external data. SAMA will continue to monitor and encourage the development of appropriate approaches to this issue.
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| 4.5.3 | In its analysis, a bank should consider the extent of any dependence between the risk of the borrower and that of the collateral or collateral provider. Cases where there is a significant degree of dependence should be addressed in a conservative manner. Any currency mismatch between the underlying obligation and the collateral should also be considered and treated conservatively in the bank’s assessment of LGD.
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| 4.5.4 | LGD estimates should be grounded in historical recovery rates and, when applicable, should not solely be based on the estimated market value of collateral. This requirement recognizes the potential inability of banks to gain both control of their collateral and liquidate it expeditiously. To the extent, that LGD estimates take into account the existence of collateral, bank should establish internal requirements for collateral management, operational procedures, legal certainty and risk management process that are generally consistent with those required for the Standardized Approach for calculating credit risk capital changes.
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| 4.5.5 | Recognizing the principle that realized losses can at times systematically exceed expected levels, the LGD assigned to a defaulted asset should reflect the possibility that the bank would have to recognize additional, unexpected losses during the recovery period. For each defaulted asset, the bank should also construct its best estimate of the expected loss on that asset based on current economic circumstances and facility status. The amount, if any, by which the LGD on a defaulted asset exceeds the bank’s best estimate of expected loss on the asset represents the capital requirement for that asset, and should be set by the bank on a risk-sensitive basis. Instances where the best estimate of expected loss on a defaulted asset is less than the sum of specific provisions and partial charge- offs on that asset will attract supervisory scrutiny and should be justified by the bank.
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| 4.5.6 | Estimation of LGD may involve mapping facility-specific data elements in a bank’s portfolio to the factors in reference data sets used by ECAIs. The mapping process should be based on a robust comparison of available common elements in the reference data and the bank’s portfolio. The bank should also have a policy describing how it combines multiple sets of reference data. Biases or inconsistencies in the mapping approach or underlying data should be avoided.
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| 4.5.7 | Banks that aggregate LGD estimates for facility grades from individual exposures should have a clear policy governing the aggregation process. In general, simple averaging is preferred. This requirement is however irrelevant for bank that choose to assign LGD estimates directly to individual exposures rather than grades, because aggregation is not required in that case.
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| 4.5.8 | For corporate, sovereign, and bank exposures, estimates of LGD should be based on a minimum data observation period that should ideally cover at least one complete economic cycle but should in any case be no shorter than a period of seven years for at least one source. If the available observation period spans a longer period for any source, and the data are relevant, this longer period should be used.
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| 4.5.9 | For retail exposures, the minimum data observation period for LGD estimates is five years. The less data a bank has, 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 loss rates.
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