Internal rating systems and processes
The Group defines a rating system as all of the methods, processes, controls, data collection and IT systems that are used for the assessment of credit risk and for classification of exposures to a pool with a specified risk level, including the rules on the priority of rating models, if applicable, and the rules for overriding rating grades. Elements of the rating system include PD, LGD, CCF-EAD models (hereinafter: models) and methodologies for evaluating specialized lending.
Evaluation of the client’s credit risk in respect to its probability of default (PD) is based on a uniform rating scale, referred to as the Master Scale.
The Master Scale (MS) consists of 15 rating grades. where the given ratings are as follows:
1. Maximum security – only for sovereigns
2. Superior quality
3. Very high quality
4. High quality
5. Very good quality
6. Good quality
7. Average high quality
8. Average quality
9. Average low quality
10. Low quality
11. Very low quality
12. Restricted crediting
13. Soft signs of impairment
14. String signs of impairment
Ratings 13 – 15 are procedural ones, reserved to exposures with deteriorated quality.
All the clients with available lending, whether or not they actually use the approved credit limits and all other participants of credit transactions should have a previously awarded rating and should be assigned to an appropriate pool.
An adequate credit or rating policy should specify the model to be used for rating purposes or a homogenous pool for a given client segment.
Each PD model used must be calibrated to MS based on the observed or estimated probability of default.
The rating for governments, central banks, international organizations, multilateral development banks and Institutions may be assigned based on a rating awarded by recognized rating agencies, mapped to the Master Scale. Should the above-mentioned entities have more than one classification awarded by recognized rating agencies (split rating) the rating corresponding to the second best risk shall be taken into account at all times. The table showing relationships between internal and external risk grades is presented in chapter 7.3 of the Disclosures. The Bank recognizes the following external rating agencies for comparison purposes: Fitch, Moody’s, Standard & Poor’s.
In case of retail customers, rating awarded through a behavioral model (behavioral rating) by default takes precedence over a rating awarded through an application model (application rating) if behavioral rating only is awarded. In case of corporate customers, awarded rating comes from a combination of a quantitative model based on an analysis of data from financial statements and on a qualitative model of customer including wages for each of components. Currently Bank is in a course of an implementation of an additional module in corporate models that is based on behavioral variables.
Procedural ratings (13. 14 and 15 according to the Master Scale) are awarded to clients showing signs of deteriorating borrowing capacity and creditworthiness or with overdue debt.
Procedural ratings by default take precedence over application ratings.
After the pre-conditions necessary to award any of the procedural ratings are no longer satisfied, ratings 13 and 14 expire immediately, while rating 15 either expires or is maintained for a “quarantine period”.
Description of the internal ratings process
1. Central governments and central banks
This exposure class is excluded permanently from the IRB approach.
This exposure class is excluded permanently from the IRB approach.
3. Corporates. including SMEs. specialized lending and purchased corporate receivables
Exposure classes subject to the plan of gradual implementation of the IRB approach.
4. Retail exposures
The rating process in Bank Millennium is based on the following principles:
- Awarding risk grades to all customers and credit exposures;
- All credit decisions should be preceded by awarding a risk grade to the client;
- In the retail segment, the rating process is based on PD scoring/rating models;
- The rating process is separated and independent from the credit decision process.
The presented rating principles apply to all categories of retail exposures: retail exposures to individuals secured by residential real estate, qualifying revolving retail exposures and other retail exposures.
The class of retail exposures to individuals secured by residential real estate include exposures which are mortgage loans or home equity loans granted to retail clients (small businesses and private individuals) and secured by mortgage.
The class of qualifying revolving retail exposures includes exposures to natural persons which are unsecured, renewable, with total exposure not exceeding EUR 100.000 and which meet the requirement of low volatility of loss rates.
All the retail exposures that do not qualify to the above categories are treated as other retail exposures. They are covered by the IRB roll-out plan, and according to the last IRB permission, IRB Approval Pack regarding these exposures was delivered on the 30th June, 2015 (update of that Approval Pack will be submitted at the turn of 2017 and 2018).
In the rating process, the powers are allocated as follows:
- Data input;
- Verification of data;
- Awarding of the final risk grade (automated decision).
Model-based risk grades and procedural ratings are awarded automatically and are not subject to expert adjustments.
In the rating process. the Bank uses data from various available sources:
- internal sources (Bank’s IT systems);
- external sources (Biuro Informacji Kredytowej S.A.);
- data received from customers.
With respect to probability of default (PD) models for retail exposures, there is a rating system in place for microbusinesses and a rating system for private individuals. Both systems use behavioral scoring models and application scoring models designed for specific client and/or product groups. Procedural ratings are awarded to clients showing signs of deteriorating borrowing capacity and creditworthiness or with past due debt.
A procedural rating has the priority in use. If the client has no procedural rating then the behavioral rating should be used, provided that it has been awarded. Behavioral rating is awarded for the first time after three months of the client’s cooperation with the Bank and then monthly, provided that the client’s accounts meet the requirements of the behavioral model. If the client has no behavioral or procedural rating then the application rating should be used.
Loss Given Default (LGD) models have been built for the following two portfolios:
- unsecured portfolio for retail clients.
- portfolio secured by residential real estate for retail clients.
Pursuant to CRR. as amended, banks must estimate LGD parameters using data on defaulted exposures from all the available sources, taking into account all information that is significant for the estimation of economic loss levels.
Accordingly, the Bank has estimated LGD parameters using a database that contains all the defaults resulting from quantitative and qualitative premises included in default definitions.
According to the LGD calculation methodology, the main factors in the calculation include: probability of cure or completion of the client recovery process, value of recoveries, costs and discount rate.
The Bank has taken the following approach to building LGD models:
- Estimate the probability of the path of cure from the default status. i.e. a probability tree;
- Estimate loss parameters for each path of cure from default.
Loss given default is estimated at a transaction level.
Exposure at Default (EAD) models
An EAD model has been built for retail portfolio exposures. When estimating EAD, exposure at default was compared to the value of the limit and the book value of the exposure observed one year before the default event. Credit Conversion Factor (CCF) parameters have been calculated for product groups for which an off-balance sheet exposure could occur and where the Bank had a significant number of observations that enabled statistical conclusions to be drawn. i.e. for overdraft limits and for credit cards. In the case of guarantees, where the number of observations was too low to carry out statistical analyses, a conservative CCF value was used. At the same time, EAD model for RRE portfolio was not developed due to immaterial number of observations.
5. Equity exposures
In equity exposures. the Millennium Group classifies shares and equity instruments held by any of the Bank’s units. On the consolidated basis, however, the shares representing investments in subsidiaries are excluded, since those are classified as intragroup transactions. However, due to the fact that the total value of the Group’s equity portfolio is insignificant, it has been decided that these exposures should be excluded from the IRB approach permanently and the capital requirement for these exposures should be calculated based on the standardized approach.
6. Exposure values and adjustments
The below table presents the basic aggregates and parameters used in calculation of own funds requirements in IRB method. As for exposure classes under IRB method, exposure amounts, CCF’s, average PD’s, debtors amount, average LGD’s, risk-weighted assets, risk density, expected loss and specific credit risk adjustments, break downed by probability of default (PD) brackets are showed.
Exposures to credit risk by exposure classes and PD brackets
and post CCF
|Average LGD||RWAs||RWA density||EL||Value
|QRRE||0.00 do <0.15||206 297||1 133 041||77.65%||1 086 081||0.08%||148 249||81.98%||47 145||4.34%||712||386|
|QRRE||0.15 do <0.25||112 053||262 370||82.57%||328 702||0.20%||58 807||77.48%||28 710||8.73%||509||234|
|QRRE||0.25 to <0.50||119 677||168 826||84.23%||261 874||0.39%||45 961||74.69%||37 965||14.50%||763||244|
|QRRE||0.50 to <0.75||162 764||138 751||84.10%||279 457||0.71%||46 869||75.49%||65 714||23.51%||1 498||367|
|QRRE||0.75 to <2.50||324 395||172 099||86.63%||473 478||1.67%||70 133||73.70%||205 915||43.49%||5 816||794|
|QRRE||2.50 to <10.00||215 105||64 265||85.36%||269 959||5.73%||38 415||75.31%||280 717||103.99%||11 735||944|
|QRRE||10.00 to <100.00||114 049||19 350||85.31%||130 556||27.84%||18 425||78.54%||278 716||213.48%||28 238||1 357|
|QRRE||100.00 (default)||103 936||3 866||0.00%||103 936||100.00%||17 095||97.98%||4 378||4.21%||101 840||48 117|
|QRRE||Razem||1 358 277||1 962 569||80.29%||2 934 042||5.73%||443 954||78.67%||949 259||32.35%||151 112||52 442|
|Residential Retail||0.00 do <0.15||17 418 586||66 358||0.00%||17 418 586||0.08%||80 660||31.40%||1 159 233||6.66%||4 375||14 327|
|Residential Retail||0.15 do <0.25||2 807 693||13 864||0.14%||2 807 712||0.19%||11 769||32.14%||369 272||13.15%||1 725||2 901|
|Residential Retail||0.25 to <0.50||1 811 681||10 440||1.96%||1 811 886||0.39%||7 602||32.25%||404 818||22.34%||2 279||2 708|
|Residential Retail||0.50 to <0.75||1 365 964||6 827||0.00%||1 365 964||0.71%||5 384||32.52%||468 281||34.28%||3 154||2 641|
|Residential Retail||0.75 to <2.50||1 722 193||12 784||0.00%||1 722 193||1.66%||6 946||32.54%||1 022 123||59.35%||9 324||4 456|
|Residential Retail||2.50 to <10.00||1 045 814||5 343||0.02%||1 045 815||5.79%||4 079||32.40%||1 235 080||118.10%||19 576||5 340|
|Residential Retail||10.00 to <100.00||809 295||647||0.00%||809 295||19.97%||2 895||33.14%||1 501 917||185.58%||53 956||9 294|
|Residential Retail||100.00 (default)||854 927||0||854 927||100.00%||2 640||64.07%||126 447||14.79%||547 748||224 861|
|Residential Retail||Total||27 836 153||116 262||0.19%||27 836 378||4.10%||121 975||32.75%||6 287 171||22.59%||642 138||266 528|
|Total (all classes)||29 194 430||2 078 831||75.81%||30 770 420||4.26%||516 058||37.12%||7 236 430||23.52%||793 250||318 969|
7. Drivers that impacted on the loss experience, in conjunction with the actual results in a longer term
For both analyzed portfolio, modeled loss amounts were much higher than actual figures. We can therefore state that there were no unexpected losses associated with LGD levels and the model used has proven to be sufficiently conservative.
The Group does not have companies conducting credit activity abroad. (CRR 452.j)