Credit risk and Basel II
EAD (Exposure at Default), PD (Probability of Default) and LGD (Loss Given Default) are important Basel II
parameters which are increasingly being used in the context of credit risk, and it is partly on these
parameters that Rabobank Group determines the economic capital and the Risk Adjusted Return On
Capital (RAROC). A significant advantage of economic capital is a streamlined and efficient approval
process.These use Basel II parameters and RAROC support credit analysts and credit committees in making
well-considered decisions. Every entity of Rabobank Group has determined a RAROC target at customer
level. Next to credit quality, this is an important factor in taking decisions on specific credit applications.
The EAD is defined as the bank's expected exposure to the client in the case of a default. As of the end
of 2008, the EAD of Rabobank Group's credit portfolio amounted to EUR 515 (465) billion. The EAD
includes the future usage of unused credit lines. In its financing approval process, Rabobank Group uses
the Rabobank Risk Rating, which reflects the counterparty's PD over a one-year period. The counterparties
have been assigned to one of the 25 rating classes, including four default ratings. Last categories are
being used if the customer defaults, varying from payment arrears of ninety days to bankruptcy.
The EAD-weighted average PD of Rabobank Group's private sector loan portfolio amounted to 1.46%
(1.55%) at year-end 2008. The weighted average PD of Rabobank Group's total loan portfolio was 1.30%
(1.39%). This lower PD is not only the result of a change in the PD of debtors, but also of policy changes
and the implementation of new models. It should be noted that the PD only reflects the extent to which
the bank expects that clients can meet their contractual obligations. The PD says nothing about the
potential loss, because in many cases Rabobank Group has obtained additional collateral. This is reflected
in the LGD, which also takes restructuring perspectives into consideration. LGD is defined as the best
estimate of the loss in case the debtor is in default, and is expressed as a percentage of EAD. At year-end
2008, LGD percentage of Rabobank Group's total portfolio was 21.6% (21.4%).
Provisions for loan losses
31-Dec-08 31-Dec-07
In millions of euros
Impaired loans
Allowances
Impaired loans
Allowances
Domestic retail banking
2,831
1,398
1,935
1,303
Wholesale banking and
international retail banking
3,182
1,536
1,191
778
Leasing
379
256
323
242
Other
182
109.
21
Rabobank Group
6,573
3,299
3,470
2,355
Once a loan has been granted, ongoing credit management takes place assessing new information,
both financial and non-financial. The bank monitors if the client meets all its obligations and to
what extend it can be expected that the client will continue to do so. If this is not the case, credit
management will be intensified, with a higher monitoring frequency and stricter monitoring of all
conditions agreed upon. Guidance is provided by a special unit within Rabobank Group, particularly in
case of larger and more complex loans granted to companies of which continuity is in danger. If it is
probable that the debtor is unable to fulfil all its contractual obligations, this is a matter of impairment
and an allowance is made which is charged to income.The allowance for loan losses contains three
components:
- The specific allowance which is determined on an individual basis for impaired loans of significant
amounts. The amount of this allowance is equal to the exposure to the customer deducted by the
present value of future cash inflows.
- The collective allowance is determined for impaired loans which individually are not significant,
notably loans to private individuals and small businesses. The allowance is set at the portfolio level,
using Basel II parameters.
- Finally the general allowance for loans which are actually impaired as at the balance sheet date, but
not yet identified as such (IBNR: Incurred But Not Reported). In this instance, too, Basel II parameters
are used to determine the amount of the allowance.
59
Report of the Executive Board
