Operational Requirements & Capital Treatment for Securitization: Supervisory Review, Study notes of Credit and Risk Management

Download Operational Requirements & Capital Treatment for Securitization: Supervisory Review and more Study notes Credit and Risk Management in PDF only on Docsity! LECTURE – 27 OPERATIONAL REQUIREMENTS & TREATMENT OF CLEAN-UP CALLS For securitization transactions that include a clean-up call, no capital will be required due to the presence of a clean-up call if the following conditions are met: (i) the exercise of the clean-up call must not be mandatory, in form or in substance, but rather must be at the discretion of the originating bank; (ii) the clean-up call must not be structured to avoid allocating losses to credit enhancements or positions held by investors or otherwise structured to provide credit enhancement; and (iii) the clean-up call must only be exercisable when 10% or less of the original underlying portfolio, or securities issued remains, or, for synthetic securitizations, when 10% or less of the original reference portfolio value remains. If a clean-up call, when exercised, is found to serve as a credit enhancement, the exercise of the clean- up call must be considered a form of implicit support provided by the bank and must be treated in accordance with the supervisory guidance pertaining to securitization transactions. Treatment of Securitization Exposure Calculation of capital requirements Banks are required to hold regulatory capital against all of their securitization exposures, including those arising from the provision of credit risk mitigants to a securitization transaction, investments in asset- backed securities, retention of a subordinated tranche, and extension of a liquidity facility or credit enhancement, as set forth in the following sections. Repurchased securitization exposures must be treated as retained securitization exposures. Operational Requirements for use of External Credit Assessments The following operational criteria concerning the use of external credit assessments apply in the standardized and IRB approaches of the securitization framework: a. To be eligible for risk-weighting purposes, the external credit assessment must take into account and reflect the entire amount of credit risk exposure the bank has with regard to all payments owed to it. For example, if a bank is owed both principal and interest, the assessment must fully take into account and reflect the credit risk associated with timely repayment of both principal and interest. b. The external credit assessments must be from an eligible ECAI as recognized by the bank’s national supervisor in accordance with paragraphs BASEL II with the following exception. “An eligible credit assessment must be publicly available. In other words, a rating must be pub ished in an accessible form and included in the ECAI’s transition matrix. Consequently, ratings that are made available only to the parties to a transaction do no satisfy this requirement.” l t c. Eligible ECAIs must have a demonstrated expertise in assessing securitizations, which may be evidenced by strong market acceptance. BASEL II & Supervisory Review Process This lecture discusses the key principles of supervisory review, risk management guidance and supervisory transparency and accountability produced by the Committee with respect to banking risks, including guidance relating to, among other things, the treatment of interest rate risk in the banking book, credit risk (stress testing, definition of default, residual risk, and credit concentration risk), operational risk, enhanced cross-border communication and cooperation, and securitization. Importance of Supervisory Review The supervisory review process of the Framework is intended not only to ensure that banks have adequate capital to support all the risks in their business, but also to encourage banks to develop and use better risk management techniques in monitoring and managing their risks. docsity.com The supervisory review process recognizes the responsibility of bank management in developing an internal capital assessment process and setting capital targets that are commensurate with the bank’s risk profile and control environment. In the Framework, bank management continues to bear responsibility for ensuring that the bank has adequate capital to support its risks beyond the core minimum requirements. Supervisors are expected to evaluate how well banks are assessing their capital needs relative to their risks and to intervene, where appropriate. This interaction is intended to foster an active dialogue between banks and supervisors such that when deficiencies are identified, prompt and decisive action can be taken to reduce risk or restore capital. Accordingly, supervisors may wish to adopt an approach to focus more intensely on those banks with risk profiles or operational experience that warrants such attention. The Committee recognizes the relationship that exists between the amount of capital held by the bank against its risks and the strength and effectiveness of the bank’s risk management and internal control processes. However, increased capital should not be viewed as the only option for addressing increased risks confronting the bank. Other means for addressing risk, such as strengthening risk management, applying internal limits, strengthening the level of provisions and reserves, and improving internal controls, must also be considered. Furthermore, capital should not be regarded as a substitute for addressing fundamentally inadequate control or risk management processes. Key Principles of Supervisory Review The Committee has identified four key principles of supervisory review, which complement those outlined in the extensive supervisory guidance that has been developed by the Committee, the keystone of which is the Core Principles for Effective Banking Supervision and the Core Principles Methodology. A list of the specific guidance relating to the management of banking risks is provided at the end of this Part of the Framework.  Principle 1: Banks should have a process for assessing their overall capital adequacy in relation to their risk profile and a strategy for maintaining their capital levels. Banks must be able to demonstrate that chosen internal capital targets are well founded and that these targets are consistent with their overall risk profile and current operating environment. In assessing capital adequacy, bank management needs to be mindful of the particular stage of the business cycle in which the bank is operating. Rigorous, forward-looking stress testing that identifies possible events or changes in market conditions that could adversely impact the bank should be performed. Bank management clearly bears primary responsibility for ensuring that the bank has adequate capital to support its risks. The five main features of a rigorous process are as follows:  Board and senior management oversight  Sound capital assessment  Comprehensive assessment of risks  Monitoring and reporting  Internal control review  Principle 2: Supervisors should review and evaluate banks’ internal capital adequacy assessments and strategies, as well as their ability to monitor and ensure their compliance with regulatory capital ratios. Supervisors should take appropriate supervisory action if they are not satisfied with the result of this process. The supervisory authorities should regularly review the process by which a bank assesses its capital adequacy, risk position, resulting capital levels, and quality of capital held. Supervisors should also evaluate the degree to which a bank has in place a sound internal process to assess capital adequacy. The emphasis of the review should be on the quality of the bank’s risk management and controls and should not result in supervisors functioning as bank management. docsity.com