BSP okays prudential framework for large exposures limit

The Bangko Sentral ng Pilipinas (BSP) has approved the prudential framework for banks and non-banks’ large exposures monitoring threshold for the detection of any solvency problems.

BSP Governor Felipe M. Medalla signed the new framework guidelines under Circular No. 1150 last Aug. 23.

BSP building and logo/Reuters

The BSP has redefined large exposures as exposures to a single counterparty or a group of connected counterparties equal to or greater than ten percent of a covered bank or quasi bank’s (QB) Tier I capital, which refers to a bank’s core capital or reserves to fund its business activities. The previous definition of large exposures was equal or greater than five percent of a financial institution’s qualifying capital. Basically, Tier 1 capital or core capital which are equity and retained earnings, is applied to monitor a bank’s capital adequacy. Qualifying capital is both Tier 2 -- which are reserves such as loan loss reserves and other capital instruments -- and Tier 1.

In the circular memo’s policy statement, Medalla said the BSP is aware of the risks arising from large exposures of banks and QBs to a single counterparty or group of connected counterparties.

He said these large exposures “could pose concerns to the stability of each bank/QB and the financial system.”

“In this light, covered banks/QBs will identify, measure, monitor and control large exposures to protect covered banks/QBs' solvency from maximum possible losses in the event of sudden counterparty failure,” said Medalla.

The large exposures framework will apply to all universal and commercial banks and their subsidiary banks and QBs. Large exposures will be computed and compared with Tier I capital on both solo and consolidated bases.

The BSP has also redefined big banks’ large exposures with a limit set at 25 percent of Tier 1 capital.

The large exposures framework imposes prudential limits to ensure banks have strong capital ratios and could cover losses in the event of a sudden collapse of a counterparty or a group of connected counterparties.

The BSP has adopted the Basel Committee on Banking Supervision standards of setting a BSP supervised financial institutions’ large exposures limit at 25 percent of Tier 1 capital. The limit is the sum of all the exposure values to a single counterparty or to a group of connected counterparties.

If a covered bank breaches the large exposures limit, it will be required to include its risk assessments in its Internal Capital Adequacy Assessment Process or ICAAP.

The guidelines on large exposures has also expanded the coverage of connected counterparties which are a group of counterparties that are connected through direct or indirect control of one of the counterparties over the other or economic interdependencies, and treated as a single counterparty.

In assessing economic interdependence, for example, the BSP has set additional criterias. The BSP refers to economic interdependence as “a situation where counterparties are reliant on each other” and therefore if one counterparty has financial problems it will affect all counterparties’ creditworthiness, in particular the covered banks.

Covered banks, previously only defined as financial institutions in the previous circular, will determine connectedness based on economic interdependence that will impact on the financial capacity or ability to pay the obligations of the other counterparties.

The BSP has several criteria for this such as: that 50 percent or more of a counterparty’s annual gross receipt or gross expenditures will come from transactions with the other counterparty; or that one counterparty has fully or partly guaranteed exposures and that exposure is so significant that the guarator is likely to default if a claim occurs.

Other criterias include: a significant part of a counterparty’s business is transacted with the other counterparty which cannot be easily replaced by business from other customers within a reasonable time period; the expected source of funds to repay the loans of both counterparties is the same and neither counterparty has another independent source of income from which the loans may be serviced and fully repaid; and it is unlikely that the financial difficulties of one counterparty would cause difficulties for the other counterparty or counterparties in terms of full and timely repayment of liabilities.