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  • 7. Risk Quantification

    • (i) Overall Requirements for Estimation

      • — Structure and Intent

        • CA-5.8.57

          This section addresses the broad standards for own-estimates of PD, LGD, and EAD. Generally, all banks using the IRB approaches must estimate a PD50 for each internal borrower grade for corporate, sovereign and bank exposures or for each pool in the case of retail exposures.

          50 Banks are not required to produce their own estimates of PD for certain equity exposures and certain exposures that fall within the SL sub-classes.

          Apr 08

        • CA-5.8.58

          PD estimates must be a long-run average of one-year default rates for borrowers in the grade, with the exception of retail exposures (see below). Requirements specific to PD estimation are provided in paragraphs CA-5.8.72 to CA-5.8.78. For retail asset class banks must estimate an appropriate LGD (as defined in paragraphs CA-5.8.79 to CA-5.8.83) for each of its retail pools and must also estimate an appropriate long- run default-weighted average EAD for each of its facilities as defined in paragraphs CA-5.8.84 and CA-5.8.85. Requirements specific to EAD estimation appear in paragraphs CA-5.8.84 to CA-5.8.89.

          Apr 08

        • CA-5.8.59

          Internal estimates of PD, LGD, and EAD must incorporate all relevant, material and available data, information and methods. A bank may utilise internal data and data from external sources (including pooled data). Where internal or external data is used, the bank must demonstrate that its estimates are representative of long run experience.

          Apr 08

        • CA-5.8.60

          Estimates must be grounded in historical experience and empirical evidence, and not based purely on subjective or judgmental considerations. Any changes in lending practice or the process for pursuing recoveries over the observation period must be taken into account. A bank's estimates must promptly reflect the implications of technical advances and new data and other information, as it becomes available. Banks must review their estimates on a yearly basis or more frequently.

          Apr 08

        • CA-5.8.61

          The population of exposures represented in the data used for estimation, and lending standards in use when the data were generated, and other relevant characteristics should be closely matched to or at least comparable with those of the bank's exposures and standards. The bank must also demonstrate that economic or market conditions that underlie the data are relevant to current and foreseeable conditions. For estimates of LGD and EAD, banks must take into account paragraphs CA-5.8.79 to CA-5.8.89. The number of exposures in the sample and the data period used for quantification must be sufficient to provide the bank with confidence in the accuracy and robustness of its estimates. The estimation technique must perform well in out-of-sample tests.

          Apr 08

        • CA-5.8.62

          In general, estimates of PDs, LGDs, and EADs are likely to involve unpredictable errors. In order to avoid over-optimism, a bank must add to its estimates a margin of conservatism that is related to the likely range of errors. Where methods and data are less satisfactory and the likely range of errors is larger, the margin of conservatism must be larger. CBB may allow some flexibility in application of the required standards for data that are collected prior to the date of implementation of this Module. However, banks must demonstrate to CBB that appropriate adjustments have been made to achieve broad equivalence to the data without such flexibility. Data collected beyond the date of implementation must conform to the minimum standards unless otherwise stated.

          Apr 08

    • (ii) Definition of Default

      • CA-5.8.63

        A default is considered to have occurred with regard to a particular obligor when either or both of the two following events have taken place:

        (a) The bank considers that the obligor is unlikely to pay its credit obligations to the banking group in full, without recourse by the bank to actions such as realising security (if held); and
        (b) The obligor is past due more than 90 days on any material credit obligation to the banking group. Overdrafts will be considered as being past due once the customer has breached an advised limit or been advised of a limit smaller than current outstandings.
        Amended: April 2011
        Apr 08

      • CA-5.8.64

        The elements to be taken as indications of unlikeliness to pay include:

        (a) The bank puts the credit obligation on non-accrued status;
        (b) The bank makes a charge-off or account-specific provision resulting from a significant perceived decline in credit quality subsequent to the bank taking on the exposure;51
        (c) The bank sells the credit obligation at a material credit-related economic loss;
        (d) The bank consents to a distressed restructuring of the credit obligation where this is likely to result in a diminished financial obligation caused by the material forgiveness, or postponement, of principal, interest or (where relevant) fees;52
        (e) The bank has filed for the obligor's bankruptcy or a similar order in respect of the obligor's credit obligation to the banking group; and
        (f) The obligor has sought or has been placed in bankruptcy or similar protection where this would avoid or delay repayment of the credit obligation to the banking group.

        51Specific provisions on equity exposures set aside for price risk do not signal default.

        52Including, in the case of equity holdings assessed under a PD/LGD approach, such distressed restructuring of the equity itself.

        Amended: April 2011
        Apr 08

      • CA-5.8.65

        CBB will periodically provide appropriate guidance as to how these elements must be implemented and monitored.

        Apr 08

      • CA-5.8.66

        For retail exposures, the definition of default can be applied at the level of a particular facility, rather than at the level of the obligor. As such, default by a borrower on one obligation does not require a bank to treat all other obligations to the banking group as defaulted.

        Apr 08

      • CA-5.8.67

        A bank must record actual defaults on IRB exposure classes using this reference definition. A bank must also use the reference definition for its estimation of PDs, and (where relevant) LGDs and EADs. In arriving at these estimations, a bank may use external data available to it that is not itself consistent with that definition, subject to the requirements set out in paragraph CA-5.8.75. However, in such cases, banks must demonstrate to CBB that appropriate adjustments to the data have been made to achieve broad equivalence with the reference definition. This same condition would apply to any internal data used up to implementation of this Module. Internal data (including that pooled by banks) used in such estimates beyond the date of implementation of this Module must be consistent with the reference definition.

        Apr 08

      • CA-5.8.68

        If the bank considers that a previously defaulted exposure's status is such that no trigger of the reference definition any longer applies, the bank must rate the borrower and estimate LGD as they would for a non-defaulted facility. Should the reference definition subsequently be triggered, a second default would be deemed to have occurred.

        Apr 08

    • (iii) Re-ageing

      • CA-5.8.69

        The bank must have clearly articulated and documented policies in respect of the counting of days past due, in particular in respect of the re-ageing of the facilities and the granting of extensions, deferrals, renewals and rewrites to existing accounts. At a minimum, the re-ageing policy must include: (a) approval authorities and reporting requirements; (b) minimum age of a facility before it is eligible for re-ageing; (c) delinquency levels of facilities that are eligible for re-ageing; (d) maximum number of re-ageings per facility; and (e) a reassessment of the borrower's capacity to repay. These policies must be applied consistently over time, and must support the 'use test' (i.e. if a bank treats a re-aged exposure in a similar fashion to other delinquent exposures more than the past-due cut off point, this exposure must be recorded as in default for IRB purposes). The CBB may choose to establish more specific requirements on re-ageing for banks.

        Apr 08

    • (iv) Treatment of Overdrafts

      • CA-5.8.70

        Authorised overdrafts must be subject to a credit limit set by the bank and brought to the knowledge of the client. Any break of this limit must be monitored; if the account were not brought under the limit after 90 days, it would be considered as defaulted. Non-authorised overdrafts will be associated with a zero limit for IRB purposes. Thus, days past due commence once any credit is granted to an unauthorised customer; if such credit were not repaid within 90, the exposure would be considered in default. Banks must have in place rigorous internal policies for assessing the creditworthiness of customers who are offered overdraft accounts.

        Apr 08

    • (v) Definition of Loss for all Asset Classes

      • CA-5.8.71

        The definition of loss used in estimating LGD is economic loss. When measuring economic loss, all relevant factors should be taken into account. This must include material discount effects and material direct and indirect costs associated with collecting on the exposure. Banks must not simply measure the loss recorded in accounting records, although they must be able to compare accounting and economic losses. The bank's own workout and collection expertise significantly influences their recovery rates and must be reflected in their LGD estimates, but adjustments to estimates for such expertise must be conservative until the bank has sufficient internal empirical evidence of the impact of its expertise.

        Apr 08

    • (vi) Requirements Specific to PD Estimation

      • — Corporate, Sovereign, and Bank Exposures

        • CA-5.8.72

          Banks must use information and techniques that take appropriate account of the long-run experience when estimating the average PD for each rating grade. For example, banks may use one or more of the three specific techniques set out below: internal default experience, mapping to external data, and statistical default models.

          Apr 08

        • CA-5.8.73

          Banks may have a primary technique and use others as a point of comparison and potential adjustment. CBB will not be satisfied by mechanical application of a technique without supporting analysis. Banks must recognise the importance of judgmental considerations in combining results of techniques and in making adjustments for limitations of techniques and information:

          (a) A bank may use data on internal default experience for the estimation of PD. A bank must demonstrate in its analysis that the estimates are reflective of underwriting standards and of any differences in the rating system that generated the data and the current rating system. Where only limited data are available, or where underwriting standards or rating systems have changed, the bank must add a greater margin of conservatism in its estimate of PD. The use of pooled data across institutions may also be recognised. A bank must demonstrate that the internal rating systems and criteria of other banks in the pool are comparable with its own;
          (b) Banks may associate or map their internal grades to the scale used by an external credit assessment institution or similar institution and then attribute the default rate observed for the external institution's grades to the bank's grades. Mappings must be based on a comparison of internal rating criteria to the criteria used by the external institution and on a comparison of the internal and external ratings of any common borrowers. Biases or inconsistencies in the mapping approach or underlying data must be avoided. The external institution's criteria underlying the data used for quantification must be oriented to the risk of the borrower and not reflect transaction characteristics. The bank's analysis must include a comparison of the default definitions used, subject to the requirements in paragraph CA-5.8.63 to CA-5.8.68. The bank must document the basis for the mapping; and
          (c) A bank is allowed to use a simple average of default-probability estimates for individual borrowers in a given grade, where such estimates are drawn from statistical default prediction models. The bank's use of default probability models for this purpose must meet the standards specified in paragraph CA-5.8.29.
          Amended: April 2011
          Apr 08

        • CA-5.8.74

          Irrespective of whether a bank is using external, internal, or pooled data sources, or a combination of the three, for its PD estimation, the length of the underlying historical observation period used must be at least five years for at least one source. If the available observation period spans a longer period for any source, and this data are relevant and material, this longer period must be used.

          Apr 08

      • — Retail Exposures

        • CA-5.8.75

          Given the bank-specific basis of assigning exposures to pools, banks must regard internal data as the primary source of information for estimating loss characteristics. Banks are permitted to use external data or statistical models for quantification provided a strong link can be demonstrated between (a) the bank's process of assigning exposures to a pool and the process used by the external data source, and (b) between the bank's internal risk profile and the composition of the external data. In all cases banks must use all relevant and material data sources as points of comparison.

          Apr 08

        • CA-5.8.76

          One method for deriving long-run average estimates of PD and default-weighted average loss rates given default (as defined in paragraph CA-5.8.79) for retail would be based on an estimate of the expected long-run loss rate. A bank may (i) use an appropriate PD estimate to infer the long-run default-weighted average loss rate given default, or (ii) use a long-run default-weighted average loss rate given default to infer the appropriate PD. In either case, it is important to recognise that the LGD used for the IRB capital calculation cannot be less than the long-run default-weighted average loss rate given default and must be consistent with the concepts defined in paragraph CA-5.8.79.

          Apr 08

        • CA-5.8.77

          Irrespective of whether banks are using external, internal, pooled data sources, or a combination of the three, for their estimation of loss characteristics, the length of the underlying historical observation period used must be at least five years. If the available observation spans a longer period for any source, and these data are relevant, this longer period must be used. A bank need not give equal importance to historic data if it can convince CBB that more recent data are a better predictor of loss rates.

          Apr 08

        • CA-5.8.78

          The CBB recognises that seasoning can be quite material for some long-term retail exposures characterised by seasoning effects that peak several years after origination. Banks must anticipate the implications of rapid exposure growth and take steps to ensure that their estimation techniques are accurate, and that their current capital level and earnings and funding prospects are adequate to cover their future capital needs. In order to avoid gyrations in their required capital positions arising from short-term PD horizons, banks are also encouraged to adjust PD estimates upward for anticipated seasoning effects, provided such adjustments are applied in a consistent fashion over time. The CBB may make such adjustments mandatory.

          Apr 08

    • (vii) Requirements Specific to Own-LGD Estimates

      • CA-5.8.79

        A bank must estimate an LGD for each facility that aims to reflect economic downturn conditions where necessary to capture the relevant risks. This LGD cannot be less than the long-run default-weighted average loss rate given default calculated based on the average economic loss of all observed defaults within the data source for that type of facility. In addition, a bank must take into account the potential for the LGD of the facility to be higher than the default-weighted average during a period when credit losses are substantially higher than average. For certain types of exposures, loss severities may not exhibit such cyclical variability and LGD estimates may not differ materially (or possibly at all) from the long-run default-weighted average. However, for other exposures, this cyclical variability in loss severities may be important and banks will need to incorporate it into their LGD estimates. For this purpose, banks may use averages of loss severities observed during periods of high credit losses, forecasts based on appropriately conservative assumptions, or other similar methods. Appropriate estimates of LGD during periods of high credit losses might be formed using either internal and/or external data. CBB will continue to monitor and encourage the development of appropriate approaches to this issue.

        Apr 08

      • CA-5.8.80

        In its analysis, the bank must consider the extent of any dependence between the risk of the borrower and that of the collateral or collateral provider. Cases where there is a significant degree of dependence must be addressed in a conservative manner. Any currency mismatch between the underlying obligation and the collateral must also be considered and treated conservatively in the bank's assessment of LGD.

        Apr 08

      • CA-5.8.81

        LGD estimates must be grounded in historical recovery rates and, when applicable, must not solely be based on the collateral's estimated market value. This requirement recognises the potential inability of banks to gain both control of their collateral and liquidate it expeditiously. To the extent, that LGD estimates take into account the existence of collateral, banks must establish internal requirements for collateral management, operational procedures, legal certainty and risk management process that are generally consistent with those required for the standardised approach.

        Apr 08

      • CA-5.8.82

        Recognising the principle that realised losses can at times systematically exceed expected levels, the LGD assigned to a defaulted asset should reflect the possibility that the bank would have to recognise additional, unexpected losses during the recovery period. For each defaulted asset, the bank must also construct its best estimate of the expected loss on that asset based on current economic circumstances and facility status. The amount, if any, by which the LGD on a defaulted asset exceeds the bank's best estimate of expected loss on the asset represents the capital requirement for that asset, and should be set by the bank on a risk-sensitive basis in accordance with paragraphs CA-5.3.3 and CA-5.4.3 to CA-5.4.5. Instances where the best estimate of expected loss on a defaulted asset is less than the sum of specific provisions and partial charge-offs on that asset will attract CBB's scrutiny and must be justified by the bank.

        Apr 08

      • CA-5.8.83

        The minimum data observation period for LGD estimates for retail exposures is five years. The less data a bank has, the more conservative it must be in its estimation. A bank need not give equal importance to historic data if it can demonstrate to CBB that more recent data are a better predictor of loss rates.

        Apr 08

    • (viii) Requirements Specific to Own-EAD Estimates

      • CA-5.8.84

        EAD for an on-balance sheet or off-balance sheet item is defined as the expected gross exposure of the facility upon default of the obligor. For on-balance sheet items, banks must estimate EAD at no less than the current drawn amount, subject to recognising the effects of on-balance sheet netting as specified in the foundation approach. The minimum requirements for the recognition of netting are the same as those under the foundation approach. The additional minimum requirements for internal estimation of EAD under the advanced approach for retail class, therefore, focus on the estimation of EAD for off-balance sheet items (excluding transactions that expose banks to counterparty credit risk as set out in Appendix CA-2). Banks must have established procedures in place for the estimation of EAD for off-balance sheet items for retail asset class. These must specify the estimates of EAD to be used for each facility type. Banks estimates of EAD should reflect the possibility of additional drawings by the borrower up to and after the time a default event is triggered. Where estimates of EAD differ by facility type, the delineation of these facilities must be clear and unambiguous.

        Apr 08

      • CA-5.8.85

        Advanced approach banks must assign an estimate of EAD for each facility. It must be an estimate of the long-run default-weighted average EAD for similar facilities and borrowers over a sufficiently long period of time, but with a margin of conservatism appropriate to the likely range of errors in the estimate. If a positive correlation can reasonably be expected between the default frequency and the magnitude of EAD, the EAD estimate must incorporate a larger margin of conservatism. Moreover, for exposures for which EAD estimates are volatile over the economic cycle, the bank must use EAD estimates that are appropriate for an economic downturn, if these are more conservative than the long- run average. For banks that have been able to develop their own EAD models, this could be achieved by considering the cyclical nature, if any, of the drivers of such models. Other banks may have sufficient internal data to examine the impact of previous recession(s). However, some banks may only have the option of making conservative use of external data.

        Apr 08

      • CA-5.8.86

        The criteria by which estimates of EAD are derived must be plausible and intuitive, and represent what the bank believes to be the material drivers of EAD. The choices must be supported by credible internal analysis by the bank. The bank must be able to provide a breakdown of its EAD experience by the factors it sees as the drivers of EAD. A bank must use all relevant and material information in its derivation of EAD estimates. Across facility types, a bank must review its estimates of EAD when material new information comes to light and at least on an annual basis.

        Apr 08

      • CA-5.8.87

        Due consideration must be paid by the bank to its specific policies and strategies adopted in respect of account monitoring and payment processing. The bank must also consider its ability and willingness to prevent further drawings in circumstances short of payment default, such as covenant violations or other technical default events. Banks must also have adequate systems and procedures in place to monitor facility amounts, current outstandings against committed lines and changes in outstandings per borrower and per grade. The bank must be able to monitor outstanding balances on a daily basis.

        Apr 08

      • CA-5.8.88

        For transactions that expose banks to counterparty credit risk, estimates of EAD must fulfill the requirements set forth in Appendix CA-2 of this Module.

        Apr 08

      • CA-5.8.89

        The minimum data observation period for EAD estimates for retail exposures is five years. The less data a bank has, the more conservative it must be in its estimation. A bank need not give equal importance to historic data if it can demonstrate to CBB that more recent data are a better predictor of drawdowns.

        Apr 08

    • (ix) Minimum Requirements for Assessing Effect of Guarantees and Credit Derivatives

      • — Standards for Corporate, Sovereign, and Bank Exposures

        • CA-5.8.90

          The minimum requirements outlined in paragraphs CA-5.8.91 to CA-5.8.100 apply to banks using the foundation LGD estimates with the following exceptions:

          (a) The bank is not able to use an 'LGD-adjustment' option; and
          (b) The range of eligible guarantees and guarantors is limited to those outlined in paragraph CA-5.3.34.
          Apr 08

      • — Standards for Retail Exposures

        • a. Guarantees

          • CA-5.8.93

            In no case can the bank assign the guaranteed exposure an adjusted PD or LGD such that the adjusted risk weight would be lower than that of a comparable, direct exposure to the guarantor. Neither criteria nor rating processes are permitted to consider possible favourable effects of imperfect expected correlation between default events for the borrower and guarantor for purposes of regulatory minimum capital requirements. As such, the adjusted risk weight must not reflect the risk mitigation of "double default."

            Apr 08

          • CA-5.8.92

            In all cases, both the borrower and all recognised guarantors must be assigned a borrower rating at the outset and on an ongoing basis. A bank must follow all minimum requirements for assigning borrower ratings set out in this section, including the regular monitoring of the guarantor's condition and ability and willingness to honour its obligations. Consistent with the requirements in section CA-5.8.43, a bank must retain all relevant information on the assignment of an exposure to a pool, and the estimation of PD.

            Apr 08

          • CA-5.8.91

            Where guarantees exist, either in support of an individual obligation or a pool of exposures, a bank may reflect the risk-reducing effect either through its estimates of PD or LGD, provided this is done consistently. In adopting one or the other technique, a bank must adopt a consistent approach, both across types of guarantees and over time.

            Apr 08

        • b. Eligible Guarantors and Guarantees

          • CA-5.8.94

            There are no restrictions on the types of eligible guarantors. The bank must, however, have clearly specified criteria for the types of guarantors it will recognise for regulatory capital purposes.

            Apr 08

          • CA-5.8.95

            The guarantee must be evidenced in writing, non-cancellable on the part of the guarantor, in force until the debt is satisfied in full (to the extent of the amount and tenor of the guarantee) and legally enforceable against the guarantor in a jurisdiction where the guarantor has assets to attach and enforce a judgement. However, in contrast to the foundation approach to corporate, bank, and sovereign exposures, guarantees prescribing conditions under which the guarantor may not be obliged to perform (conditional guarantees) may be recognised under certain conditions. Specifically, the onus is on the bank to demonstrate that the assignment criteria adequately address any potential reduction in the risk mitigation effect.

            Apr 08

          • CA-5.8.98

            In adjusting borrower grades or LGD estimates (or in the case of retail and eligible purchased receivables, the process of allocating exposures to pools), banks must take all relevant available information into account.

            Apr 08

          • CA-5.8.97

            The criteria must be plausible and intuitive, and must address the guarantor's ability and willingness to perform under the guarantee. The criteria must also address the likely timing of any payments and the degree to which the guarantor's ability to perform under the guarantee is correlated with the borrower's ability to repay. The bank's criteria must also consider the extent to which residual risk to the borrower remains, for example a currency mismatch between the guarantee and the underlying exposure.

            Apr 08

        • c. Adjustment Criteria

          • CA-5.8.96

            A bank must have clearly specified criteria for adjusting borrower grades or LGD estimates (or in the case of retail and eligible purchased receivables, the process of allocating exposures to pools) to reflect the impact of guarantees for regulatory capital purposes. These criteria must be as detailed as the criteria for assigning exposures to grades consistent with paragraphs CA-5.8.22 and CA-5.8.23, and must follow all minimum requirements for assigning borrower or facility ratings set out in this section.

            Apr 08

        • d. Credit Derivatives

          • CA-5.8.99

            The minimum requirements for guarantees are relevant also for single-name credit derivatives. Additional considerations arise in respect of asset mismatches. The criteria used for assigning adjusted borrower grades or LGD estimates (or pools) for exposures hedged with credit derivatives must require that the asset on which the protection is based (the reference asset) cannot be different from the underlying asset, unless the conditions outlined in the foundation approach are met.

            Apr 08

          • CA-5.8.100

            In addition, the criteria must address the payout structure of the credit derivative and conservatively assess the impact this has on the level and timing of recoveries. The bank must also consider the extent to which other forms of residual risk remain.

            Apr 08

    • (x) Requirements Specific to Estimating PD and LGD (or EL) for Qualifying Purchased Receivables

      • CA-5.8.101

        The following minimum requirements for risk quantification must be satisfied for any purchased retail receivables making use of the top-down treatment of default risk and/or the IRB treatments of dilution risk.

        Apr 08

      • CA-5.8.102

        The purchasing bank will be required to group the receivables into sufficiently homogeneous pools so that accurate and consistent estimates of PD and LGD (or EL) for default losses and EL estimates of dilution losses can be determined. In general, the risk bucketing process will reflect the seller's underwriting practices and the heterogeneity of its customers. In addition, methods and data for estimating PD, LGD, and EL must comply with the existing risk quantification standards for retail exposures. In particular, quantification should reflect all information available to the purchasing bank regarding the quality of the underlying receivables, including data for similar pools provided by the seller, by the purchasing bank, or by external sources. The purchasing bank must determine whether the data provided by the seller are consistent with expectations agreed upon by both parties concerning, for example, the type, volume and on-going quality of receivables purchased. Where this is not the case, the purchasing bank is expected to obtain and rely upon more relevant data.

        Apr 08

      • — Minimum Operational Requirements

        • CA-5.8.103

          A bank purchasing receivables has to justify confidence that current and future advances can be repaid from the liquidation of (or collections against) the receivables pool. To qualify for the top-down treatment of default risk, the receivable pool and overall lending relationship should be closely monitored and controlled. Specifically, a bank will have to demonstrate the following:

          Apr 08

      • — Legal Certainty

        • CA-5.8.104

          The structure of the facility must ensure that under all foreseeable circumstances the bank has effective ownership and control of the cash remittances from the receivables, including incidences of seller or servicer distress and bankruptcy. When the obligor makes payments directly to a seller or servicer, the bank must verify regularly that payments are forwarded completely and within the contractually agreed terms. As well, ownership over the receivables and cash receipts should be protected against bankruptcy 'stays' or legal challenges that could materially delay the lender's ability to liquidate/assign the receivables or retain control over cash receipts.

          Apr 08

      • — Effectiveness of Monitoring Systems

        • CA-5.8.105

          The bank must be able to monitor both the quality of the receivables and the financial condition of the seller and servicer. In particular:

          (a) The bank must (i) assess the correlation among the quality of the receivables and the financial condition of both the seller and servicer, and (ii) have in place internal policies and procedures that provide adequate safeguards to protect against such contingencies, including the assignment of an internal risk rating for each seller and servicer;
          (b) The bank must have clear and effective policies and procedures for determining seller and servicer eligibility. The bank or its agent must conduct periodic reviews of sellers and servicers in order to verify the accuracy of reports from the seller/servicer, detect fraud or operational weaknesses, and verify the quality of the seller's credit policies and servicer's collection policies and procedures. The findings of these reviews must be well documented;
          (c) The bank must have the ability to assess the characteristics of the receivables pool, including (i) over-advances; (ii) history of the seller's arrears, bad debts, and bad debt allowances; (iii) payment terms, and (iv) potential contra accounts;
          (d) The bank must have effective policies and procedures for monitoring on an aggregate basis single-obligor concentrations both within and across receivables pools; and
          (e) The bank must receive timely and sufficiently detailed reports of receivables ageings and dilutions to (i) ensure compliance with the bank's eligibility criteria and advancing policies governing purchased receivables, and (ii) provide an effective means with which to monitor and confirm the seller's terms of sale (e.g. invoice date ageing) and dilution.
          Amended: April 2011
          Apr 08

      • — Effectiveness of Work-out Systems

        • CA-5.8.106

          An effective programme requires systems and procedures not only for detecting deterioration in the seller's financial condition and deterioration in the quality of the receivables at an early stage, but also for addressing emerging problems pro-actively. In particular:

          (a) The bank should have clear and effective policies, procedures, and information systems to monitor compliance with (i) all contractual terms of the facility (including covenants, advancing formulas, concentration limits, early amortisation triggers, etc.) as well as (ii) the bank's internal policies governing advance rates and receivables eligibility. The bank's systems should track covenant violations and waivers as well as exceptions to established policies and procedures;
          (b) To limit inappropriate draws, the bank should have effective policies and procedures for detecting, approving, monitoring, and correcting over-advances; and
          (c) The bank should have effective policies and procedures for dealing with financially weakened sellers or servicers and/or deterioration in the quality of receivable pools. These include, but are not necessarily limited to, early termination triggers in revolving facilities and other covenant protections, a structured and disciplined approach to dealing with covenant violations, and clear and effective policies and procedures for initiating legal actions and dealing with problem receivables.
          Amended: April 2011
          Apr 08

      • — Effectiveness of Systems for Controlling Collateral, Credit Availability and Cash

        • CA-5.8.107

          The bank must have clear and effective policies and procedures governing the control of receivables, credit, and cash. In particular:

          (a) Written internal policies must specify all material elements of the receivables purchase programme, including the advancing rates, eligible collateral, necessary documentation, concentration limits, and how cash receipts are to be handled. These elements should take appropriate account of all relevant and material factors, including the seller's/servicer's financial condition, risk concentrations, and trends in the quality of the receivables and the seller's customer base; and
          (b) Internal systems must ensure that funds are advanced only against specified supporting collateral and documentation (such as servicer attestations, invoices, shipping documents, etc.).
          Amended: April 2011
          Apr 08

      • — Compliance with the Bank's Internal Policies and Procedures

        • CA-5.8.108

          Given the reliance on monitoring and control systems to limit credit risk, the bank must have an effective internal process for assessing compliance with all critical policies and procedures, including:

          (a) Regular internal and/or external audits of all critical phases of the bank's receivables purchase programme; and
          (b) Verification of the separation of duties (i) between the assessment of the seller/servicer and the assessment of the obligor and (ii) between the assessment of the seller/servicer and the field audit of the seller/servicer.
          Amended: April 2011
          Apr 08

        • CA-5.8.109

          A bank's effective internal process for assessing compliance with all critical policies and procedures should also include evaluations of back office operations, with particular focus on qualifications, experience, staffing levels, and supporting systems.

          Apr 08