Credit Risk

Hi all - not sure what the etiquette is on here, but I have a separate (unrelated) question - I'll just ask it here - but if there is a better place, can the site moderator move it please. I wasn't at the PRA Round Table event, but there was mention of some proposed actions (1 or 2 attendees had a clear view) - were the actions documented anywhere? Or if not, would somebody be able to provide a short summary of the key points we raised with the PRA for action? It sounds like there has been no progress on this.

I have seen that and a bit of controversy around it Promise-to-pay on its own is not a concession… agreeing to pause the contractual dunning process & associated late-fees, however, can be easily seen as one — materiality concerns should apply here, though - banks could easily put an optional clause of ‘dunning-process & collecting/waiving late fees at sole discretion of the bank’ into the contract at which point there no longer is a concession-event vs pre-agreed optionality Financial difficulties is where you also would want to differentiate: is a delay of 2-3 months, below 90dpd, credible auto-cure by the end really a situation of financial difficulties? Here it is easy to define materiality thresholds that pass the EBA guidelines JST/ Inspectors I speak with are typically a bit more concerned with banks being 'laissez faire' with this, than with the actual risk. I have seen cases where the bank had no policy or controls around this and then it resulted in a finding on potential underestimation of forbearance / S2 -- proper policy writing and guidance to relationship managers should close the perceived governance gap There is a clear understanding of bad incentives: if you punish banks for agreeing with clients in this way by enforcing a cure period that is worse than 'do nothing', it clearly creates a conflict, that should be put on the table when arguing against an overly conservative view. But careful that not all 'silent acceptance' of delays are then afterwards equated with active concessions

I think most use a blended approach, with the largest / riskiest LPs getting a deeper review and others being rated based on higher level characteristics. LPs who are too risky and/or cant be rated should get kicked out of the borrowing base. NB: I don’t think LP risk is the only criteria, and similar to a reply above, Fund and GP factors are also really important (if not more so). Given the lack of historical defaults, it’s important to have a good conceptual understanding of what could drive defaults… which varies based on the type of LP, the legal frameworks for the LP’s commitments, and the likelihood of things going sideways for the fund/GP. Worth skimming the characteristics the ratings agencies use to assess sub lines for some additional color. (portfolios of sub lines get rated both for distribution to US Life Insurers, who rely on IG ratings, and for other distribution mechanisms). Summarized nicely by KBRA below Subscription Lines: Why Are Ratings Needed? https://www.kbra.com/publications/KKbkyMsj/subscription-lines-why-are-ratings-needed?format=file Subscription Finance Rating Criteria [Fitch] https://www.fitchratings.com/research/fund-asset-managers/subscription-finance-rating-criteria-08-06-2023 Methodology For Rating Subscription Lines Secured By Capital Commitments [S&P] https://disclosure.spglobal.com/ratings/en/regulatory/article/-/view/sourceId/13199000 Subscription Credit Facilities: Proposed methodology [Moodys] https://ratings.moodys.com/api/rmc-documents/410678

If you have any questions or comments please reply to this thread!

@OP In which case, No change in default level – new Soft UTP is not adding any defaults (there must be fully correlated to any existing trigger or triggers e.g. 90DPD, bankruptcy, etc.) No timing difference of default event – therefore no PD or LGD impact even due to discounting Client has only limited historic time series to show proof Both 1 and 2 indicate there is full correlation to already existing triggers at the existing time period (but level of correlation can differ at time (t) for each trigger toward the new Soft UTP trigger). Based on the other responses to this question, a bootstrapping would be the correct approach, but the bank states on recent periods the outcome should be NULL (or similar like that) Therefore, an idea could be to simulate the uncertainty of the correlation in different macroeconomic environments Correlation analysis of macro economic factor vs existing triggers over time (t) Given that new Soft UTP trigger is correlated toward multiple triggers at time (t) (based on existing time period the bank has), the correlation variation found of each underlying existing trigger can be used to proxy new Soft UTP trigger back in time PLUS above should still be supplemented with a qualitative statement

We’ve seen a variant of this issue in US/Canada, with the large Canadian Banks generally having IRB approval at the Group level (including for their main US loan books) and their US subsidiaries being on standardized In this case, there is no incentive for the US entity to seek IRB approval - but US regulators do care about the risk rating systems from a bank supervision perspective, which has raised some of the same questions about whether group models are suitable. Those banks have generally taken a view aligned to a previous poster, i.e., using local models for middle market and below, and trying to align to group models for larger companies and FI's On the last point, I'll say that we've seen US regulators challenge the support for those decisions heavily, but at least in some cases it seems to have stood up to that challenge.  In one case where the bank's prior analysis and documentation didn't provide great support, they are being pushed to redevelop those as well, though they are trying to do so in a way that they can ultimately extend back to group as well, for a C&I model that was getting a bit long in the tooth anyway

I'll just flag that a Canadian bank who had decided to extend several of their existing "global" models to their US subsidiary based on similar logic, and while the logic makes sense broadly, they ran into significant issues with their US subsidiary’s regulator about the way they did it I would primarily attribute the root causes of those issues to: Operating model for how those decisions were taken and where they were reviewed and challenged – the Group development and validation teams led the substantive assessment of “fit-for-use”, and while there were some US stakeholders involved, the ones most involved were not very senior in stature, and often deferred to the expertise of Group.  But those US stakeholders then couldn’t / didn’t do a good job of credibly defending those decisions to their regulators, leading the regulators to question if US senior management had been sufficiently involved in determining that these models were appropriate for the US portfolio The documentation they produced justifying and validating the use of these models in the US was a narrow “fit for use assessment”, which taken as a standalone artifact fell far short of the comprehensive model documentation and validation expectations of SR 11-7.  This led regulators to question the “effective challenge” provided by US model risk management and more broadly by US senior management

Thanks a lot, this was very helpful!

Very interesting point. Would be great to know OW's experience with feedback from other players.

I suspect the answer will depend on what regulators require – for example the PRA expects all FIRB firms to use effective maturity (there’s currently a carve-out for SMEs, but they want to remove that too under Basel 3.1 – see below) I have to admit, I cannot recollect what ECB/ EBA has had to say about this, but I think it would be pretty hard to justify using it in most places but not some – would very much feel like a bank would be open to challenge around whether it was cherry-picking PRA CP16/22 proposal around Effective Maturity 4.305 The PRA currently specifies within IRB permissions that firms using the FIRB approach must calculate effective maturity rather than apply fixed parameters. This is because the PRA considers that calculation of effective maturity is a more risk-sensitive approach, which better reflects the economic substance of the exposures, and thus enhances the safety and soundness of firms. Furthermore, using effective maturity facilitates effective competition because firms using the AIRB approach are also required to apply the effective maturity approach. 4.306 The PRA proposes to maintain the substance of its existing approach and that firms using  the FIRB approach would continue to be required to apply the effective maturity approach. The PRA proposes to include this provision in its rules as it considers this would be more appropriate than applying the requirement on a firm-by-firm basis as is currently the case. 4.307 The PRA considers that the proposed approach is in line with the Basel 3.1 standards as these include a discretion for national supervisors to require firms using the FIRB approach to calculate effective maturity for all exposures. 4.308 Similarly, to improve risk-sensitivity, the PRA proposes to remove the option currently setout in the CRR that allows firms that are otherwise calculating maturity to instead apply fixed maturity values for exposures to small UK corporates.