Sound credit risk assessment and valuation for loans
June 2006
Objective and summary
This paper is being issued by the Basel Committee on Banking Supervision to
address how common data and processes related to loans may be used for
assessing credit risk, accounting for loan impairment and determining
regulatory capital requirements. The guidance supersedes Sound practices for loan accounting and disclosure, published by the
Committee in July 1999, and is structured around ten principles that fall
within two broad categories:
Supervisory expectations concerning sound credit risk assessment and valuation
for loans
- The bank's board of directors and senior management are responsible for
ensuring that the banks have appropriate credit risk assessment processes and
effective internal controls commensurate with the size, nature and complexity
of the bank's lending operations to consistently determine provisions for
loan losses in accordance with the bank's stated policies and procedures,
the applicable accounting framework and supervisory guidance.
- Banks should have a system in place to reliably classify loans on the basis of
credit risk.
- A bank's policies should appropriately address validation of any internal
credit risk assessment models.
- A bank should adopt and document a sound loan loss methodology, which addresses
credit risk assessment policies, procedures and controls for assessing credit
risk, identifying problem loans and determining loan loss provisions in a
timely manner.
- A bank's aggregate amount of individual and collectively assessed loan loss
provisions should be adequate to absorb estimated credit losses in the loan
portfolio.
- A bank's use of experienced credit judgement and reasonable estimates are
an essential part of the recognition and measurement of loan losses.
- A bank's credit risk assessment process for loans should provide the bank
with the necessary tools, procedures and observable data to use for assessing
credit risk, accounting for impairment of loans and for determining regulatory
capital requirements.
Supervisory evaluation of credit risk assessment for loans, controls and capital
adequacy - Banking supervisors should periodically evaluate the effectiveness of a
bank's credit risk policies and practices for assessing loan quality.
- Banking supervisors should be satisfied that the methods employed by a bank to
calculate loan loss provisions produce a reasonable and prudent measurement of
estimated credit losses in the loan portfolio that are recognized in a timely
manner.
- Banking supervisors should consider credit risk assessment and valuation
policies and practices when assessing a bank's capital adequacy.
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