Section III. Other Matters
3.1. Rescheduled Loans
A restructured troubled loan arises when a bank, for economic or legal reasons related to the obligor’s financial difficulties, grants him a concession that it would not otherwise consider. A bank should measure a restructured troubled loan by reducing the recorded outstanding to net realizable value as required by the relevant accounting standards, taking into account the cost of all concessions at the date of restructuring. The reduction in the outstanding amount should be recorded as a charge to the income statement in the period in which the loan is restructured.
In cases where non-performing loans in particular are rescheduled, such loans should not be upwardly reclassified merely because of the existence of a rescheduling agreement. Upward reclassification should only be made if and when there is sufficient evidence of adherence to the terms of the rescheduling agreement. This evidence would include the establishment of a history for at least 12 months of timely repayments of both principal and commission/interest under the rescheduling agreement.
3.2. Overdrafts
Formal procedures should be put into place to support the determination of the classification of an overdraft based on transactions within the overdraft and in particular the timeliness of repayments of commission/income.
As a minimum, these procedures should include:
• Periodic systematic comparison of the aggregate value of credits in the overdraft account with the repayments due and other debits in the account.
• Understanding the nature and source of the credits in the account.
• Review of the history of the account balance.
3.3. Collateral
Prudent and proper valuation of collateral is critical to the determination of provisions. Proper procedures should be put into place to value collateral on a periodic basis, at least once a year, using external appraisers or external reliable published information. In cases where judgment is used in the valuation of the collateral and where the collateral or the credit is significant, valuations should be carried out by more than one external appraiser. In general, collateral obtained for consumer credit and similar credits where large number of relatively small balances is outstanding would be excluded from such requirements. The valuations so obtained should be adjusted downwards by an appropriate percentage to reflect costs of disposal, fluctuations in market values and the inherent lack of accuracy in such valuations.
3.4. The Basel Capital Accord and Provisioning
The Basel 2 Capital Accord provides incentives to internationally active banks to develop and implement sophisticated and advance system for measuring and capturing credit, market and operational risks. For credit risk, it encourages banks to develop and implement sophisticated internal ratings based approaches. As a minimum, it requires all credit risk on the bank’s banking book to be classified into a system that has as a minimum 7 grades for performing loans and one for non-performing loans. It also requires banks to gather data for a minimum of 3 years on their history of losses arising from loan defaults. Data gathered from such systems permits banks and supervisors to collect information on Probability of Default (PD), Loss Given Default (LGD), and Expected Amount at Default (EAD). Such data permits banks to compute a capital charge for capital ratio purposes, using the risk weighted assets models designed by Basel under the IRB approach.
SAMA encourages all Saudi banks to understand, develop and implement, where cost-justified and appropriate, IRB approaches for capital adequacy purposes. While the IRB systems are primarily aimed at computation of regulatory capital, it is understood that the information on historical loss experience may have relevance for a bank’s calculation of general provisions. Consequently, SAMA will encourage Saudi banks to look into ways of aligning their capital adequacy and provisioning methodologies.