4.2 Definition of Default for Different Asset Classes

No: BCS 290

Date(g): 12/6/2006 | Date(h): 16/5/1427

Status: No longer applicable

	General definition of default.
4.2.1	A default is considered to have occurred with regard to a particular obligor when either or both of the two following events have taken place:
	•	A bank considers that the obligor is unlikely to pay in full its credit obligations to the bank (or the banking group¹ of which it is a part), without recourse by the bank to actions such as realizing security (if held);
	•	The obligor is past due for more than 90 days² on any material portion of its credit obligations to the bank (or the banking group of which it is a part). Past due credit obligations are regarded as material if they represent 5% or more of the obligor’s outstanding credit obligations. Banks may however set a lower threshold or choose not to apply the threshold based on their individual circumstances. Overdrafts will be considered as past due once the customer has breached an advised limit or been advised of a limit smaller than the current outstanding balance (see also paragraph 4.2.7). The criteria for determining overdue assets are set out in SAMA’s circular BCS # 312 of 19.1.2004 entitled “SAMA’s Rules Concerning Loan Classifications, Provisioning and Credit Review”.
4.2.2	The elements to be taken as indicators of unlikeliness to pay include:
	A Bank puts the credit obligation on non-accrual status.
	•	The criteria for putting an obligation on non-accrual status and those for restoring the “accrual” status are set out in SAMA’s circular # 312 of 19.1.2004 entitled “SAMA circular on loan classification, provisioning and credit review”.
	•	A bank makes a charge-off or account-specific provision resulting from a significant perceived decline in asset quality subsequent to the bank taking on the exposure³;
	•	A bank sells the credit obligation at a material credit related economic loss;
	•	A bank gives consent to a distressed restructuring/rescheduling of the credit obligation where this is likely to result in a diminished financial obligation caused by the material forgiveness, or postponement, of principal, interest or, where relevant, fees.⁴ The criteria for determining rescheduled assets and those for uplifting the “rescheduled” status are set out SAMA’s circular # 312⁵.
	•	A bank has filed for the obligor’s bankruptcy or a similar order in respect of the obligor’s credit obligation to the bank;
	•	The obligor has sought or has been placed in bankruptcy or similar protection where this would avoid or delay repayment of the credit obligation to the bank.
4.2.3	For retail exposures, the definition of default can be applied at the level of a particular facility, rather than at the level of the obligor. As such, default by a customer on one obligation does not require a bank to treat all other obligations of the customer to the bank (or its banking group) as defaulted.
4.2.4	Banks should record actual defaults on IRB asset classes using the reference definition mentioned above. They should also use the reference definition for their estimation of PDs, and, where relevant, LGDs and EADs. In arriving at these estimations, banks may use external data available to them that are not itself consistent with that definition, subject to the requirements set out in paragraphs 4.4.3 to 4.4.7.
4.2.5	In such cases, however, bank should demonstrate to the SAMA that appropriate adjustments to the data have been made to achieve broad equivalence with the reference definition. The same condition would apply to any internal data used up to the time when a bank adopts the IRB Approach. Larger discrepancies require larger adjustments for the sake of conservatism. Internal data (including those pooled by bank) used in such estimates beyond the date of adoption of the IRB Approach should be consistent with the reference definition.
4.2.6	If a bank considers that the status of a previously defaulted exposure is such that the trigger of the reference definition no longer applies, the bank should rate the borrower and estimate LGD as it would for a non-defaulted facility. Should the reference definition be subsequently triggered, a second default would be deemed to have occurred.

Treatment of overdrafts

4.2.7

Overdraft facilities authorized by a bank to a customer should be subject to a formal credit limit and brought to the knowledge of the customer. Any breach of this limit should be monitored. If the account were not brought under the limit after 90 days, it would be considered as defaulted. Temporary or non-authorized overdrafts will be associated with a zero limit for IRB purposes. Thus, the days past due commence once any credit is granted to the customer concerned. If such credit were not repaid within 90 days, the exposure would be regarded as in default. Banks should have in place rigorous internal policies for assessing the credit-worthiness of customers who are offered overdraft accounts.

	Re-ageing
4.2.8	Re-ageing is a process by which the delinquency status of loans, the terms of which have not been changed, is adjusted based on subsequent good performance, even though not all arrears under the original repayment schedule have been paid off.
	The bank must have clearly articulated and documented policies in respect of the counting of days past due, in particular in respect of the re-ageing of the facilities and the granting of extensions, deferrals, renewals and rewrites to existing accounts. At a minimum, the re-ageing policy must include: (a) approval authorities and reporting requirements; (b) minimum age of a facility before it is eligible for re-ageing; (c) delinquency levels of facilities that are eligible for re-ageing; (d) maximum number of re-ageings per facility; and (e) a reassessment of the borrower‘s capacity to repay. These policies must be applied consistently over time, and must support the ‘use test’ (i.e. if a bank treats a re-aged exposure in a similar fashion to other delinquent exposures more than the past-due cut off point, this exposure must be recorded as in default for IRB purposes). Some supervisors may choose to establish more specific requirements on re-ageing for banks in their jurisdiction.
	(Refer para 458, International Convergence of Capital Measurement and Capital Standards – June 2006).

¹ The banking group covers all entities within the group that are subject to the capital adequacy regime in Saudi Arabia.
² In the event that a branch owned by a foreign banking group wants to use a different default trigger set by its home supervisor for particular exposures (e.g. 180 days for exposures to retail or public sector entities), the bank will need to satisfy SAMA that such a difference in the definition of default will not result in any material impact on the default and loss estimates generated. Where necessary, if the relevant models are centrally developed and validated at the home country, the views of the home supervisor will be sought.
³ Specific provisions on equity exposures set aside for price risk do not necessarily signal default.
⁴ Including, in the case of equity holdings assessed under a PD/LGD approach, such distressed restructuring of the equity itself.
⁵ Also see “Rescheduled Loans”, SAMA circular # 312 of 19.1.2004, which provides guidance on the definition of “rescheduled loans”.