QIS 3 FAQ: J. Provisions

1. How should specific provisions against non-defaulted assets be treated?

Answer: Most specific provisions will be created against defaulted assets. The Committee realises, however, that in some cases relatively small specific provisions will be created against non-defaulted assets. For QIS-purposes, such provisions should be allocated to the pool for general provisions (such amounts must be separately identified in the 'Notes' spreadsheet). The QIS-treatment differs from the Technical Guidance, which indicates that a specific provision on a non-defaulted asset will be used to offset the EL-charge on this asset. Surpluses will not be eligible to offset the capital charges on any other asset (see paragraph 331 of the Technical Guidance). If a bank or supervisor is of the opinion that treating all specific provisions on non-defaulted assets, as surplus general provisions will result in a material misrepresentation of QIS-findings for this bank, only the portion of such provisions eligible upon implementation can be included.

2. If an obligor only defaults on part of an exposure, wouldn't it be more consistent to declare only this part of the exposure in default and create a specific provision against it?

Answer: The proposed capital accord uses a PD-definition that is obligor-specific. Each obligor should have one, unique PD. This automatically implies that all exposures of an obligor will go into default simultaneously.4 Consequently, the amount in default and the exposure size will be identical. Exposures must be measured as the amount legally owed, i.e. gross of any provisions. The provisions will be used to offset the capital charge on the defaulted asset.

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    An example may clarify this. If an obligor defaulted on a total loan amount of 100 with an LGD of 45% and the bank creates a provision of 45 the risk weighted assets equal 12.5 X ((45% X 100) - 45) = 0, which reflects the fact that any expected losses have been provisioned for. If we would have corrected exposure size rather than capital charges risk weighted assets would have equalled 12.5 X 45% (100 - 45) = 12.5 X 24.75 which would have been too high.

3. In some jurisdictions provisions exist that are specific to a certain portfolio (e.g. all loans to a specific industry or loans to obligors in a specific country). How should such portfolio specific provisions be treated?

Answer: For purposes of QIS you may treat such provisions as if they were general provisions (indicate the amounts involved in the 'Notes' spreadsheet). The QIS-treatment differs from the Technical Guidance, which indicates that such provisions are available to offset the EL-portion of the capital charge against the portfolio to which they relate. If a bank or supervisor is of the opinion that treating all portfolio specific provisions as surplus general provisions will result in a material misrepresentation of QIS-findings for this bank, only the portion of such provisions eligible according to the Technical Guidance can be included.

4. What does the item 'general provisions not included' in capital mean?

Answer: General provisions are only eligible as tier 2 capital up to a maximum of 1.25% of risk weighted assets. Some banks may have an amount of provisions above this limit. Moreover, some banks may not be able to include general provisions in tier 2 capital since they would otherwise breach the limit of tier 2 to tier 1 capital. The amount of provisions not included in capital (i.e. any amount in excess of one of the caps mentioned in the previous sentence) should be reported here and will be used to offset the EL-component of capital requirements under the IRB-approaches.

5. Under IRB a new treatment for specific and general provisions has been introduced. Is there also a special treatment for provisions under the standardised approach?

Answer: No. As under the 1988 Accord, under the standardised approach exposures are measured net of specific provisions and charge offs. In this regard, nothing has changed (more information on the treatment of specific provisions under the IRB approaches is available on the BIS website http://www.bis.org/publ/bcbs_wp5.htm).

4 As indicated in paragraph 343 of the technical instructions there are two exceptions two this rule. Firstly, in the case of country transfer risk, where a bank may assign different borrower grades depending on whether the facility is denominated in local or foreign currency. Secondly, when the treatment of associated guarantees to a facility may be reflected in an adjusted borrower grade. In either case, separate exposures may result in multiple grades for the same borrower.

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