Credit risk and Basel II
Rabobank Group uses the Advanced Internal Rating Based (Advanced IRB) approach for credit
risk. This is the most risk-sensitive of the Basel II credit risk approaches. Rabobank Group has
professionalised its risk management further by combining Basel II compliance activities with
the implementation of a best-practice framework for economic capital. The main Basel II
parameters as far as credit risk is concerned are EAD (Exposure at Default), PD (Probability of
Default) and LGD (Loss Given Default). The economic capital and Risk Adjusted Return On
Capital (RAROC) are determined partly on the basis of these parameters. A significant
advantage associated with the use of economic capital is a streamlined, efficient approval
process. Using the Basel II parameters and RAROC helps credit analysts and credit committees
make well-considered decisions. Every group entity has established a RAROC target at
corporate client level. Alongside credit quality, this is an important factor when taking
decisions on specific credit applications. In addition, the Basel II parameters mentioned above
are an important element of management information at portfolio level. EAD is the best
estimate of the extent to which a bank may be exposed in the event and at the time of a
counterparty's default. At year-end 2012, the EAD of Rabobank Group's total Advanced IRB
loan portfolio was EUR 606 (606) billion. This EAD includes the expected future usage of
unused credit lines.
As part of its approval process, Rabobank Group uses the Rabobank Risk Rating system, which
indicates the counterparty's PD over a one-year period. The rating is cyclically neutral in
principle. The counterparties are categorised in 25 rating classes, which include four default
ratings. These default ratings are assigned if the client defaults, the form of which may range
from payment arrears of 90 days to bankruptcy.
At year-end 2012, the EAD weighted average PD of Rabobank Group's total performing
Advanced IRB loan portfolio stood at 1.03% (1.06%).The improvement in the PD was caused by
a change in the PD of existing debtors as well as by changes in the composition of the portfolio
(inflow and outflow of clients), the implementation of new models and policy changes.
It should be noted that this PD only reflects the extent to which clients are expected to be
able to meet their obligations. The PD does not provide any indication as to the potential
losses, because Rabobank Group has in many cases secured additional collateral. This is
reflected in the LGD, which also takes the possibility of restructuring into consideration.
The LGD is the estimated economic loss that will result if the debtor defaults, expressed as a
percentage of the EAD. At year-end 2012, the LGD percentage of Rabobank Group's total
Advanced IRB portfolio was 21.8% (22.0%).
Impaired loans and allowance for loan losses
Once a loan has been granted, ongoing credit management takes place, as part of which new
information, both financial and non-financial, is assessed.The bank ascertains whether the
client is fulfilling all its obligations and whether it can be expected to continue to do so in
future. If not, credit management is stepped up, monitoring becomes more frequent, and a
closer eye is kept on credit terms. Guidance is provided by a special unit within Rabobank
Group, particularly in the case of larger, more complex loans granted to businesses whose
ability to continue as a going concern is at stake. If it is likely that a debtor will be unable to
fulfil all its contractual obligations to Rabobank Group, this is considered impairment.
If necessary, an allowance is formed that is charged to income. The allowance for loan losses
consists of three components, as described below.
- The specific allowance is determined on an individual basis for impaired corporate loans
representing significant sums. This allowance is equal to the exposure to the client less the
discounted value of future cash inflows.
- The collective allowance is determined for impaired loans which individually are not
significant, i.e. primarily loans to private individuals and small businesses. The allowance is
set at portfolio level, using IFRS-adjusted Basel II parameters.
- The general allowance is determined for loans that are actually impaired at the balance
sheet date but have not yet been identified as such (IBNR:'Incurred But Not Reported').
In this case, too, IFRS-adjusted Basel II parameters are used to determine the amount of
the allowance.
54 Annual Report 2012 Rabobank Group
