Basel Committee issues credit risk guidance
27 July 1999
The Basel Committee on Banking Supervision today issued four papers providing guidance to banks and banking supervisors on various aspects of credit risk in banking activities. These papers form part of an ongoing effort by the Committee to strengthen procedures for risk management in banks. Mr William J McDonough, Chairman of the Basel Committee and President and Chief Executive Officer of the Federal Reserve Bank of New York, said: "We know from experience that weak credit risk management practices and poor credit quality can pose a serious threat to the stability of banks and banking systems. In issuing this package with credit risk guidance, the Basel Committee is continuing its efforts to foster safe and sound banks and banking systems worldwide."
Accounting for loans and loan losses
The paper Sound practices for loan accounting and disclosureaddresses a range of issues facing banks and bank supervisors in the accounting for loans and loan losses. "Sound and prudent loan accounting practices are critical not only to adequate management and control of credit risks in banks. Sound practices are also important to ensure accurate and transparent financial reporting and prudent calculation of bank capital," noted Prof. Dr Arnold Schilder, Executive Director of the Netherlands Bank and Chairman of the Basel Committee's Task Force on Accounting Issues, the group in charge of developing the guidance.
This paper is a revised version of a consultative paper issued in October 1998. "We have received comments from a broad range of countries and organisations, including bankers, accountants, standard-setters, regulators and supervisors from all around the world," said Mr Schilder. "Apart from many general expressions of support, commentators have raised a number of important issues. I would like to take this opportunity to acknowledge the great contribution of many people that have provided comments and taken part in this effort to fill a gap in existing international guidance."
Papers issued for comment by 30 November
1. Management of credit risk
The consultative paper Principles for the management of credit riskencourages banking supervisors globally to promote sound practices for managing credit risk. The paper emphasises that banks must manage the credit risk in all their activities, both in the banking book and in the trading book, and on and off the balance sheet. The paper is organised around 17 principles related to: (1) establishing an appropriate credit risk environment; (2) operating under a sound credit granting process; (3) maintaining an appropriate credit administration, measurement and monitoring process; (4) ensuring adequate controls over credit risk; and (5) the role of supervisors.
Mr Roger Cole, Co-chair of the Committee's Risk Management Group, noted that "exposure to credit risk continues to be the leading source of problems in banks in both the G10 and non-G10 countries. Recent events demonstrate the importance of sound credit infrastructures at banks to the stability of global financial systems. The practices set out in this document should be applied in conjunction with the other sound practice papers being issued today."
2. Credit risk disclosure
The consultative paper Best practices for credit risk disclosureidentifies the types of credit risk information market participants and supervisors need in order to make a meaningful assessment of a bank, and encourages banks in all countries to provide such information to the public. The paper provides disclosure recommendations in five broad areas: accounting policies and practices, credit risk management, credit exposures, credit quality, and earnings. The best practices guidance in this paper provides comprehensive recommendations with respect to disclosure of credit risk not only in banks' lending activities, but also in all other types of banking activities.
"Informed investors, counterparties, and other market participants are an important element in a stable, healthy banking environment," said Ms Susan Krause, Senior Deputy Comptroller for International Affairs at the Office of the Comptroller of the Currency of the United States and Chair of the Basel Committee's Transparency Group, which developed the paper. "We conducted interviews with a wide range of information users as well as research into actual credit risk disclosure practices in various countries. The results demonstrated that there is a clear demand for more comprehensive and accurate information on credit risk than currently exists. The publication of this paper represents an effort to fill those gaps."
3. Management of FX settlement risk
The consultative paper Supervisory guidance for managing settlement risk in foreign exchange transactionsis being issued as part of the credit risk package as settlement risk clearly has a credit risk dimension. The guidance contained in this paper builds on the work undertaken by the Basel-based Committee on Payment and Settlement Systems, in particular its reports on Settlement risk in foreign exchange transactions (March 1996) and Reducing foreign exchange settlement risk: a progress report (July 1998). The paper emphasises that foreign exchange settlement risk should be managed through a formal process, including appropriate policies, procedures and limits, and with adequate senior management oversight. The paper also includes a list of possible questions related to foreign exchange settlement risk for supervisors to ask banks during on-site reviews.
Ms Christine Cumming, Co-chair of the Committee's Risk Management Group, stated that "settlement risk exists for any traded product but, given the size of the foreign exchange market, for many banks foreign exchange transactions form the greatest source of settlement risk exposure. Consequently, it is important that supervisors determine that banks have appropriate methods of managing foreign exchange settlement risk."
Invitation to comment
The three papers on risk management and disclosure are issued for consultation. The Basel Committee invites comments on the proposals from all interested parties, including bankers, rating agencies, analysts, industry groups, standard-setters and supervisors. These comments, which will be considered in the finalisation of the papers, must be received no later than 30 November 1999.
Notes to editors
Basel Committee on Banking Supervision
The Basel Committee on Banking Supervision is a committee of banking supervisory authorities which was established by the central bank Governors of the Group of Ten countries in 1975. It consists of senior representatives of bank supervisory authorities and central banks of Belgium, Canada, France, Germany, Italy, Japan, Luxembourg, the Netherlands, Sweden, Switzerland, the United Kingdom and the United States. Its current chairman is Mr William J McDonough, President and Chief Executive Officer of the Federal Reserve Bank of New York. The Committee usually meets at the Bank for International Settlements (BIS) in Basel, where its permanent Secretariat is located.
Risk Management Group
The Basel Committee's Risk Management Group has the mission to develop guidance for supervisors and encourage sound industry practices across a broad range of risk management and internal control topics. The Group is co-chaired by Mr Roger Cole, Associate Director at the Board of Governors of the Federal Reserve System and Ms Christine Cumming, Senior Vice President at the Federal Reserve Bank of New York. Reports produced by the Risk Management Group include
- Principles for the management of interest rate risk (September 1997)
- Framework for internal control systems in banking organisations (September 1998)
- Operational risk management (September 1998).
The Basel Committee's Transparency Group has the lead responsibility in the Committee's consideration of public disclosure and regulatory reporting issues. It is chaired by Ms Susan Krause, Senior Deputy Comptroller for International Affairs at the Office of the Comptroller of the Currency of the United States. Reports produced by the Transparency Group include
- Framework for supervisory information about derivatives and trading activities (September 1998)
- Enhancing bank transparency (September 1998)
- Trading and derivatives disclosures of banks and securities firms - results of the survey of 1997 disclosures (November 1998)
- Recommendations for public disclosure of trading and derivatives activities of banks and securities firms (consultative paper, February 1999).
Task Force on Accounting Issues
The Basel Committee's Task Force on Accounting Issues has the lead responsibility in the Committee's consideration of accounting and auditing issues. It is chaired by Prof. Dr Arnold Schilder, Executive Director of the Netherlands Bank, who in January 1999 succeeded Mr Nick LePan, Deputy Superintendent of the Office of the Superintendent of Financial Institutions, Canada.
Where can I obtain the full reports?
The text of the four reports published today can be obtained from the BIS website (www.bis.org) as from 12.30 CET on 27 July 1999. They are also available from the Basle Committee's Secretariat at the BIS and from member bank supervisory authorities and central banks.