6. Treatment of Expected Losses and Recognition of Provisions
Calculation of expected losses
A bank must sum the EL amount (defined as EL multiplied by EAD) associated with its exposures (excluding the EL amount associated with equity exposures under the PD/LGD approach and securitization exposures) to obtain a total EL amount. While the EL amount associated with equity exposures subject to the PD/LGD approach is excluded from the total EL amount, paragraphs 376 and 386, International Convergence of Capital Measurement and Capital Standards – June 2006 apply to such exposures. The treatment of EL for securitization exposures is described in paragraph 563, International Convergence of Capital Measurement and Capital Standards – June 2006.
(Refer para 375, International Convergence of Capital Measurement and Capital Standards – June 2006)
6.1 Expected Loss for Exposures other than SL Subject to the Supervisory Slotting Criteria
Banks should calculate the EL as PD x LGD for corporate, sovereign, bank and retail exposures not in default. For corporate, sovereign, bank and retail exposures that are in default, Banks should use their best estimate of EL as defined in paragraph 4.5.5 of “Minimum Requirements for Risk Quantification under IRB Approach”, and banks on the Foundation IRB Approach should use the supervisory LGD. For SL exposures subject to the supervisory slotting criteria, the EL is calculated as described in paragraph 6.2 below.
6.2 Expected Loss for SL Exposures Subject to the Supervisory Slotting Criteria
For SL exposures subject to the supervisory slotting criteria, the EL amount is determined by multiplying by 8% the risk-weighted assets produced from the appropriate risk weights, as specified in the following paragraph, multiplied by EAD.
The risk weights for SL are as follows:
• Strong
5% • Good
10% • Satisfactory
35% • Weak
100% • Default
625% SAMA may allow banks to assign preferential risk weights to other SL exposures falling into the “strong” and “good” supervisory categories as outlined in paragraph 4.1.8 above. The corresponding EL risk weight is 0% for “strong” exposures, and 5% for “good” exposures.
Supervisory categories and the risk weights for HVCRE:
The risk weights for HVCRE are as follows:
Strong
Good
Satisfactory
Weak
Default
5%
5%
35%
100%
625%
Even where, at national discretion, supervisors allow banks to assign preferential risk weights to HVCRE exposures falling into the “strong” and “good” supervisory categories as outlined in paragraph 282, the corresponding EL risk weight will remain at 5% for both “strong” and “good” exposures.
(Refer para 379, International Convergence of Capital Measurement and Capital Standards – June 2006)
Calculation of provisions
6.3 Exposures Subject to the IRB Approach
Total eligible provisions are defined as the sum of all provisions (e.g. specific provisions, partial write-offs, portfolio-specific general provisions such as country risk provisions or general provisions1) that are attributed to exposures treated under the IRB Approach. Specific provisions set aside against equity should not be included in total eligible provisions.
1 Banks adopting Accounting Standard IAS #39 or other similar standard may wish to note that the accounting changes arising the reform could have implications on the scope and extent of general provisions to be included in Supplementary Capital under the revised capital adequacy framework.
6.4 Treatment of Expected Losses and Provisions
Bank using the IRB Approach should compare the amount of total eligible provisions with the total EL amount as calculated within the IRB Approach. In addition, where a bank is also subject to the Standardized Approach to credit risk for a portion of its credit exposures, general provisions can be included in a bank supplementary capital subject to the limit of 1.25% of risk-weighted assets.
Where the EL amount exceed the total eligible provision, banks should deduct the difference from the capital base at 50% from Tier-1 and 50% from Tier -II.
Where the calculated EL amount is lower than the provisions of the bank, its supervisors must consider whether the EL fully reflects the conditions in the market in which it operates before allowing the difference to be included in Tier 2 capital. If specific provisions exceed the EL amount on defaulted assets this assessment also needs to be made before using the difference to offset the EL amount on non-defaulted assets.
(Refer para 385, International Convergence of Capital Measurement and Capital Standards – June 2006)
The EL amount for equity exposures under the PD/LGD approach is deducted 50% from Tier 1 and 50% from Tier 2. Provisions or write-offs for equity exposures under the PD/LGD approach will not be used in the EL-provision calculation.
The treatment of EL and provisions related to securitization exposures is outlined in paragraph 563.
(Refer para 386, International Convergence of Capital Measurement and Capital Standards – June 2006)