• CM-3 CM-3 Developing a Sound Credit Culture

    • CM-3.1 CM-3.1 Overview

      • CM-3.1.1

        Credit culture is defined as the sum total of a bank's approach to managing credit risk, including business strategy, credit policy, shared assumptions about credit, the effectiveness of communications, and the composition and quality of the resulting loan portfolio.

        October 07

      • CM-3.1.2

        As a matter of best practice, all banks should periodically review their credit cultures in order to reduce future credit losses and also to minimise reputational risk and damage to their credit ratings.

        October 07

      • CM-3.1.3

        The CBB draws all licensed banks' attention to the September 2000 document issued by the Basel Committee entitled 'Principles for the Management of Credit Risk'. This document contains 17 principles which all banks should ensure are covered in their credit culture (i.e. policies, procedures, systems and controls) (see www.bis.org/publ/bcbs75.pdf).

        Amended: January 2011
        October 2007

      • CM-3.1.4

        Effective from the date of the original circular (see Section CM-A.3), the CBB will use the Basel document mentioned above as a guideline in its evaluation of the credit cultures of banks operating in Bahrain. Evaluation will be implemented through prudential meetings, inspection and reporting accountants' reviews.

        Amended: January 2011
        October 2007

    • CM-3.2 CM-3.2 Elements of a Strong Credit Culture

      • CM-3.2.1

        First, the regulation in this Section is recommendatory in nature (except for the requirement in Paragraphs CM-3.2.2 (a) & (e) below), and the guidelines below under the five headings are indicative of best practice. Some of the guidelines may not be appropriate to all relevant licensees. However, if a bank is not following these guidelines, it should consider why it is not doing so.

        October 07

      • CM-3.2.2

        Secondly, the regulation in this Section is intended as a complement to the September 2000 Paper by the Basel Committee entitled 'Principles for the Management of Credit Risk' (see Section CM-B.2). This Section does not summarise the Basel Paper, but is intended to be read in conjunction with the above Paper.

        (a) The Role of the Board of Directors

        The Board of Directors must approve all the operating policies of a bank (see principle 1 of Basel Committee paper, 'Framework for Internal Control Systems in Banking Organisations' – Section CM-B.2).

        Given that credit risk is still the major risk that banks are exposed to in their business, particular scrutiny must be paid to credit policies, in terms of various limits as well as in terms of risk strategy. An essential function of the Board is to review and reassess the credit policies of the bank (including collateral, provisioning policies and concentration policies) on a periodic basis. The Board should also regularly review overdue and large facilities both in terms of performance, and also in relation to the capital (base) of the bank. The Board should insist upon periodic review/evaluation of internal systems and control weaknesses identified by external/internal auditors and management. Principle 1 of the Basel Committee paper 'Principles for the Management of Credit Risk' (see Section CM-B.2) also gives greater detail on the role of the Board in developing a sound credit culture.
        (b) The Role of the senior management

        Senior Management should be involved in regular reviews of outstanding facilities and overdue accounts as well as reviewing changes in activity, turnover or balances in clients' accounts. The role of senior management is covered in depth in Principle 2 of Basel Committee paper 'Principles for the Management of Credit Risk' – Section CM-B.2 (see also Principle 3 of Basel Committee paper 'Framework for Internal Controls Systems in Banking Organisations' – Section CM-B.2). However, Senior Management should be involved in the credit review process of (larger) existing facilities, visiting clients, requesting up to date financial statements and verifying collateral. Too often, a lack of direct contact by senior management with a problem client has been an identified factor in significant credit losses by banks, whether by way of fraud, or corporate failure.
        (c) Role of an Independent Risk Management Function

        Perhaps the key point to emphasise in Risk Management is that the function must be independent of the senior management and operational functions which are related to business acquisition. The Risk Management function should report to the Board or to senior management related to control functions. The Risk Management function must not only monitor risk, but also control it (i.e. review limits, excesses etc). It must also ensure that risk monitoring systems accurately measure risk in the first place, and that all risks where they occur are correctly identified (see also Principle 6 of Basel Committee paper, 'Framework for Internal Controls Systems in Banking Organisations' ' – Section CM-B.2).
        (d) Effective Internal Systems and Controls

        Well implemented sound policies and procedures maintain credit standards, enable monitoring and control of credit risk, and identify problem credits in a timely manner (see Principle 2 of Basel Committee paper 'Principles for the Management of Credit Risk' – Section CM-B.2 for more detail). Sound policy and administrative requirements also apply equally strongly to existing facilities as well as new ones (see Principle 8 of Basel Committee paper 'Principles for the Management of Credit Risk' – Section CM-B.2). Policies and procedures should allow a thorough understanding of the counterparty, the purpose of the credit facility and the source of repayment (Principle 4 of Basel Committee paper 'Principles for the Management of Credit Risk' – Section CM-B.2) to be gained by the Risk Management function in its assessment of the counterparty for risk profiling purposes, (see also Principle 6 of Basel Committee paper 'Framework for Internal Controls Systems in Banking Organisations' – Section CM-B.2 and Section E of the paper issued by the Counterparty Risk Management Policy Group - 'Improving Counterparty Risk Management' – see Section CM-B.2). Banks should seek to utilise internal rating systems to manage credit risk and to set adequate provisions on a timely basis (see Principle 10 of Basel Committee paper 'Framework for Internal Controls Systems in Banking Organisations' – Section CM-B.2 and also the Credit Ratings in Section CM-2.2).
        (e) The Role of Internal Audit

        The internal audit function must, on an on-going basis, monitor the system of internal controls because it provides an independent assessment of the adequacy of, and compliance with, the established policies and procedures. The internal audit function must report directly to the highest levels of the banking organisation, typically the Board of Directors or its audit committee, and to senior management. This allows for the proper functioning of corporate governance by giving the Board information that is not biased in any way by the levels of management that the reports cover.
        October 07

    • CM-3.3 CM-3.3 Name-lending

      • CM-3.3.1

        Banks are exposed to credit risk when they provide large credit facilities on a 'clean' basis (i.e. without collateral or security). This risk is amplified, specifically, when such clean lending is made without adequate (up to date) financial information.

        October 07

      • CM-3.3.2

        In many banks there is a tendency to indulge in 'name-lending' without any credit analysis or understanding of the concerned counterparty's current borrowings from other banks. The CBB strongly discourages the banks to engage in such activities in order to minimise their credit risk and reputational risk.

        Amended: January 2011
        October 2007