6.2 Credit Risk measurement
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Consolidated Financial Statements Company Financial Statements Pillar 3
by the management of the entity based on their position in
the organisation, knowledge, experience and management
responsibilities. Rabobank considers it a priority that the credit
committees are comprised of high level (senior) management
representation with a significant level of experience in the
respective credit area.
The credit committees play a key role in ensuring consistency
among Rabobank standards of credit analysis, compliance with
the overall Rabobank credit policy and consistent use of the
rating models.The credit policy sets the parameters and remit
of each committee, including the maximum amount they are
allowed to approve for limits or transactions. Policies are also in
place which restrict or prohibit certain counterparty types or
industries. As a rule, all counterparty limits and internal ratings
are reviewed once a year (corporate clients) at a minimum.
Where counterparties are assigned a low loan quality
classification they are reviewed on a more frequent basis. Credit
committees may request for more frequent reviews as well.
Credit Risk Measurement Framework
Internal credit models are used to estimate PD, LGD and EAD
parameters. Rabobank uses different modelling methodologies
for the different portfolios. Ranging from statistical models to
expert-based models, and taking into account quantitative and
qualitative risk drivers.The credit risk parameters are used in the
calculation of the capital requirements.
Decisions that determine the level of credit risk accepted by
Rabobank are not only based on quantitative information or
model output. Practical and conceptual limitations of metrics
and models using a qualitative approach including expert
judgment and critical analysis are also taken into account.
After obtaining permission from the Dutch Central Bank,
Rabobank has been using the most advanced methods
for capital calculations since 1 January 2008. Rabobank
applies the Internal Ratings Based (IRB) approach for the vast
majority of its credit portfolio (including retail) to calculate its
regulatory capital requirements according to CRR (CRD IV).
The IRB approach is the most sophisticated and risk-sensitive
of the CRR (CRD IV) approaches for credit risk, allowing
Rabobank to make use of its internal rating methodologies
and models. Rabobank combines CRR (CRD IV) compliance
activities with a Pillar II framework. The approach represents
key risk components for internal risk measurement and risk
management processes. Key benefits are a more efficient credit
approval process, improved internal monitoring and reporting
of credit risk. Another important metric is the Risk Adjusted
Return On Capital (RAROC) for a transaction as part of the credit
application. This enables credit risk officers and committees to
make better informed credit decisions.
The IRB approach uses the Probability of Default (PD), Loss
Given Default (LGD), Exposure at Default (EAD) and Maturity (M)
as input for the regulatory capital formula, where:
Risk metric Abbreviation Description
Probability of Default PD The likelihood that a counterparty
will default within one year.This is a
forward-looking measure.
Loss Given Default LGD The estimate of the economic loss in
the situation of a default, expressed
as a percentage of the Exposure at
Default (EAD).
Exposure at Default EAD (EUR) The expected exposure in case a
counterparty defaults.
Maturity M(t) The remaining expected maturity.
The Risk-Weighted Exposure Amount (RWEA) and the Expected
Loss (EL) are calculated based on these parameters.The RC
requirements are calculated as 8% of RWEA.
The differences between the actual IRB provision made for the
related exposure and the EL is adjusted for in the capital base.
The negative difference (when the EL amount is larger than
the provision amount) is defined as the Internal Ratings Based
Shortfall. According to CRR (CRD IV) rules, the shortfall amount
is deducted from the CET1 capital, AT1 capital and T2 capital.
For the deduction from the CET1 Capital a transition scheme
applies and the deduction moves from AT1 and T2 to CET1
The shortfall amount in 2016 was 1,042.
Risk classification and internal rating system
An important element in the risk analysis for credit applications
is the classification of the credit risk by assigning an internal
rating to each credit counterparty.This is a borrower rating
reflecting the likelihood of a counterparty becoming unable
to repay the loan or to fulfil other debt obligations.Together
with the introduction of the Basel II framework, Rabobank
developed the Rabobank Risk Rating (RRR) master scale,
comprising 21 performing ratings (R0-R20) and 4 default
ratings (D1-D4).The performing ratings correspond with
the PD of the client. The D1-D4 ratings represent default
classifications. D1 represents a minimum of 90 days of arrears,
D2 a high probability that the debtor is unlikely to pay, D3 that
the debtor is unable to meet its obligations and foreclosure
is required, and D4 is the status of bankruptcy. In accordance
with this approach, all D-ratings constitute the total defaulted
exposure. Each RRR is associated with a range for the PD in basis
points and an average PD in basis points (seeTable 1).The RRR
for a specific counterparty is determined based on internally
326 Rabobank Jaarverslag 2016