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Guidelines for Managing Large Exposures and Credit Risk Concentrations

01.09.2004

The Monetary Board has approved the guidelines on Managing Large Exposures and Credit Risk Concentrations intended to support the policy on Single Borrower’s Limit (SBL). The forthcoming circular lays down minimum standards for banks/NBQBs to comprehensively manage large exposures on both stand-alone and group basis.

The Circular focuses on the following principles for managing large exposures and credit risk concentrations:

a.)  Banks can be exposed to various forms of credit risk concentrations which if not properly managed may cause significant losses that could threaten their financial strength and undermine public confidence.

b.)  Credit risk concentrations may arise from excessive exposures to individual counterparties, groups of related counterparties and groups of counterparties with similar characteristics (e.g. counterparties in specific geographical locations, economic or industry sectors). It is essential for banks to prevent undue credit risk concentrations.

c.)  Banks should conduct stress testing and scenario analysis of their large exposures to assess the impact of changes in market conditions or key risk factors.

It underscores the responsibility of the Board of Directors for establishing and monitoring compliance with policies governing large exposures and credit risk concentrations of the bank. The Board should review these policies at least annually.

The policy on large exposures and credit risk concentrations shall, at a minimum cover the following:

a.)  Exposure limits that are reasonable in relation to capital and resources for various types of borrowers/counterparties, group of related borrowers/counterparties, individual industry sectors, individual countries and various types of investments.

b.)  Circumstances in which the above limits can be exceeded and party authorized to approve such excesses, e.g. the bank’s board of directors or credit committee with delegated authority from the board.

c.)  Delegation of credit authority within the bank for approving large exposures.

d.)  Procedures for identifying, reviewing, managing and reporting large exposures of the bank.

e.)  Definition of exposure. Banks should take into account the nature of their business and the complexity of their products.

f.)  Criteria to be used for identifying a group of related persons.

In monitoring large exposures, the Circular requires banks to have: (1) a central liability record to be able to track credit exposures preferably based on automated system; (2) an adequate management information and reporting system; (3) an annual review of the quality of large exposures and controls to safeguard against credit risk concentrations to be conducted by external or internal auditors; (4) a prompt corrective action mechanism to address concerns and exceptions raised; and (5) an independent compliance function to ensure that all relevant internal and prescribed requirements and limits are complied with.

Non-observance of the principles and requirements under the Circular as may be determined during examination may be a ground for a finding of unsafe and unsound practice under Section 56 of the General Banking Law of 2000, and may be subject to appropriate sanction as determined by the Monetary Board.

The issuance of the Circular is in line with the objective of strengthening credit risk management in the banking system.

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