Note: These questions and answers are intended for QIS-4 purposes only.
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Major Topics of FAQs:
- Wholesale Portfolios
- Retail Portfolios
- Credit Risk Mitigation
- Securitization Exposures
- Equity Exposures
- Operational Risk
- Other
Wholesale Portfolios
Question: Would you please clarify what is meant by "translation risk" in question 18 of the QIS-4 questionnaire? (January 24, 2005)
Answer: The term "translation risk" refers to transfer risk, or the risk that a customer borrowing in a non-local currency will be unable through its Central Bank and local capital markets to gain access to that currency and service the debt, regardless of its own financial circumstances. Most other translation risk (or foreign currency risk) that a bank incurs from lending in a local currency would likely be managed through its trading activities and captured for regulatory capital purposes through the VaR charge on trading. Any unhedged local currency exposures that the lending function retains (e.g., long-term exposures for which there are no active markets and, therefore, that traders cannot hedge) should also be considered for QIS-4 purposes, provided that your bank's information systems can identify them.
Question: Where counterparties have posted financial collateral supporting over-the-counter (OTC) derivatives, can banks reflect the collateral by using either the loss given default (LGD) or exposure at default (EAD) adjustment methods? (January 24, 2005)
Answer: Yes, as explained in paragraph 85 of the QIS-4 instructions, either approach can be applied as long as a bank is consistent for all OTC derivative products.
Question: Do we need to generate our own haircuts for repo-style transactions and over the counter (OTC) derivatives to be eligible for the advanced internal-ratings based (A-IRB) approach? (January 24, 2005)
Answer: As noted in Appendix C of the QIS-4 instructions, standard supervisory haircuts are permitted, so you do not need to generate your own haircuts to be eligible for the A-IRB approach.
Question: Could you please provide some insight regarding the maturity we should assign to commercial credit cards and corporate overdrafts? (January 24, 2005)
Answer: You should try to estimate the maturity of these exposures using historical data. Paragraph 91 of the QIS-4 instructions states that the value of the maturity should be the "weighted average remaining maturity of the expected cash flows, using the amounts of the cash flows as weights." You should note that despite the fact that these exposures may be "unconditionally cancelable," they would be viewed as being part of an institution's ongoing financing of a borrower and therefore not eligible for the exemption from the one-year maturity minimum, which is described in paragraph 92 of the QIS-4 instructions.
Question: On the Current sheet, the cells in section 1c, Sov-Bank-Corp Counterparty exposures: Repo-style transactions, ask for information on a gross basis. The gross balances are then risk weighted. Under current US capital adequacy guidelines, net repo balances (which are net of FIN 41) are risk weighted. For QIS-4, should we enter repos net of FIN 41? (January 24, 2005)
Answer: Yes, for QIS-4 please report repos as the notional amount taking into account netting permitted under FIN 41.
Question: Could you please provide additional clarity on which instruments would be exempt from the requirement that maturity not be less than one year for wholesale portfolios? In paragraph 92 of the QIS-4 instructions, it is specified that exceptions on the lower bound of one year apply to transactions that (a) are not part of an institution's ongoing financing of a borrower and (b) have original maturity of less than three months - including repo-style transactions, money market transactions, trade finance-related transactions, and exposures arising from payment and settlement processes. Specifically, would inter-bank placements (assuming they meet the criteria outlined above) be exempt from the one-year maturity minimum? Would loans originated under forward flow agreements be exempt from the one-year maturity minimum? These latter are loans, such as mortgage or home equity line of credit (HELOC), that are originated under an agreement to be purchased by another institution in a very short time period (e.g., less than 30 days). (January 7, 2005)
Answer: Paragraph 92 of the QIS-4 instructions is not intended to provide an exhaustive list of all types of transactions that could be exempt from the one-year maturity requirement (provided that they also meet criteria a and b, as described above). Other instruments that could have a maturity of less than one year include federal funds, US Treasury bills, municipal notes, government-sponsored enterprise securities, shares in money market instruments, futures contracts, futures options, swaps, trade-related letters of credit, bankers' acceptances, inter-bank placements, and due from banks. As noted in paragraph 92, for these transactions, maturity may be set as low as five days for repo-style transactions and OTC derivatives subject to a qualifying master netting agreement, and as low as one day for other wholesale transactions. Short-term commercial paper and forward flow agreements would not be exempt from the one-year maturity minimum.
Question: We are planning to include our high net worth portfolio in the wholesale portfolio, as they do not meet the requirements for retail treatment. We wanted to confirm that this treatment is appropriate, as the definition of corporate in the QIS-4 instructions does not include exposures to individuals. (January 7, 2005)
Answer: In general, a bank has flexibility to classify loans to high net worth individuals as corporate or retail, based upon the unique circumstances of the transactions. However, all retail exposures -- including those to such individuals -- must meet the requirements for retail treatment, as outlined in the recently released draft retail guidance. That guidance requires: (1) the exposure to be managed on a pool basis, and (2) the obligor to be an individual, except for those qualifying as retail business exposures. Institutions should note that loans primarily secured by residential properties may be treated as residential mortgage loans, without size limit and regardless of how the funds are used. The "Other Retail" category also contains no limit on the size of the exposure, but, as with all exposures treated as retail, must meet the "pooled" and "individual" criteria cited above. If exposures to high net worth individuals do not meet these conditions, banks should report them as corporate exposures. Note that retail margin lending is excluded from the internal-ratings based capital requirements for QIS-4 purposes.
Question: Should we add back interest applied to principal to the loan balance of defaulted assets, as is done for partial charge-offs? (January 7, 2005)
Answer: Yes, interest applied to principal should be added back to the balance of a defaulted loan.
Question: We do not currently have complete financial information (i.e., annual revenues) to apply the small- and medium-sized enterprise (SME) threshold test. Is it acceptable to use management/organizational definitions, based upon size cutoffs, to identify SME exposures? (January 7, 2005)
Answer: You should use a "best efforts" approach in reporting SMEs. Organizational definitions would be one approach. You should describe in detail the approach used to identify and allocate SMEs in the QIS-4 questionnaire.
Question: Does the presence of a Credit Support Annex (CSA) Agreement have an impact on the assumed maturity (M) when calculating the capital requirement for over-the-counter (OTC) derivative transactions? (January 7, 2005)
Answer: No. The existence of a CSA Agreement as a supplement to a master netting agreement in an OTC derivative transaction does not permit a bank to reduce M below the one-year floor. The master netting agreement allows a bank to use the exposure at default (EAD) approach for recognition of collateral in OTC derivative transactions. The bank may assume a ten-day holding period when adjusting the collateral value to reflect potential market price volatility. For OTC derivative transactions subject to qualifying master netting agreements, M should be set equal to the weighted-average remaining maturity of the individual transactions, using the notional amounts of the individual transactions as the weights. An exception to the one-year floor on M is available for OTC derivative transactions subject to qualifying master netting agreements that (a) are not part of an institution's ongoing financing of a borrower and (b) have a maturity of less than three months. When those conditions are satisfied, M may be set as low as five days.
Question: When calculating the maturity for derivative exposures, should the five-year cap be applied at the transaction level or at the final result level? For example, assume we have a customer with the following two derivative exposures that are covered under an International Swaps and Derivatives Association (ISDA) agreement: (January 7, 2005)
Transaction # Type Notional Maturity 1 Interest Rate Swap $100 1 year 2 Interest Rate Swap $200 30 years Should M be equal to:
1 2
Answer: The five-year cap should be applied at the transaction level. In the above example, M would equal 3.667 years.
Question: In the above example, what would maturity (M) equal if the customer's exposures were not covered under an International Swaps and Derivatives Association (ISDA) agreement? (January 7, 2005)
Answer: If the two transactions are not covered under an ISDA master netting agreement, they would be treated as two separate transactions: one with a maturity of one year, and the second with a maturity of five years. However, the net effect on M is the same as if two transactions were subject to a master netting agreement: assuming the two exposures are slotted into the same probability of default (PD)/loss given default (LGD) bucket, M for that bucket is calculated as a weighted-average maturity for the exposures in that bucket.
Question: Are government sponsored entities (GSEs) corporate or bank exposures? (December 21, 2004)
Answer: Under the advanced internal ratings-based (AIRB) approach, it doesn’t matter if GSEs are treated as corporate or bank exposures: the same risk-weight function applies to both. The important point to note is that they are subject to the probability of default (PD) floor of three basis points.
Question: Would you please clarify when bank inputs that are lower than the specified floors on parameters for certain exposures are or are not overridden by these floors in the relevant formulas in the QIS-4 worksheets? Examples of floors include the three basis point floor for probability of default (PD) for all corporate, bank (including government sponsored entities), and state and local government exposures, and the 10 percent floor for loss given default (LGD) for retail mortgages. (December 21, 2004)
Answer: The Sov-Bank-Corp worksheet will not override bank inputs for either PDs or LGDs with any prescribed floors. As paragraph 71 of the QIS-4 instructions states, "under the advanced internal ratings-based (AIRB) approach, all corporate, bank (including government sponsored entities), and state and local government exposures are subject to a PD floor of 0.03 percent." Therefore, PDs below 0.03 percent should reflect only sovereign exposures.
The worksheets for the following portfolios will impose a 0.03 percent PD floor but will not impose an LGD floor: SME Corporate, HVCRE, IPRE, QRE, RBE, and Other Retail.
For HELOCs and Other Mortgage, both a 0.03 percent floor for PDs and a 10 percent floor for LGDs will be imposed and will override any input below these levels. Nonetheless, please enter your actual LGD estimates, even if below 10 percent.
Question: Should we exclude from the data any exposures to US and sovereign counterparties that have a probability of default (PD) of zero? Examples of such exposures include US Treasury securities in banks’ investment portfolios. (December 21, 2004)
Answer: Banks should include data for exposures with a zero PD. The spreadsheets accommodate such entries, and the risk-weight functions allow for them. Please see previous question for further information on this topic.
Question: The Mid-Year-Text indicates that a 2.5 year effective maturity default value for small- and medium-sized enterprises (SMEs) treated as corporate exposures is subject to national discretion. However, the advanced notice on proposed rulemaking (ANPR) is silent on this point. Should SMEs therefore be subject to the same maturity rules as corporate exposures? (December 21, 2004)
Answer: Yes, treat maturity for SMEs as you would for large corporate exposures.
Question: Should all short-term wholesale exposures between three and 12 months default to a one-year maturity? (December 21, 2004)
Answer: Yes, short-term wholesale exposures between three and 12 months should be assigned a maturity of one year. As explained in paragraph 92 of the QIS-4 instructions, exceptions on the lower bound of one year apply to transactions that (a) are not part of an institution’s ongoing financing of a borrower and (b) have an original maturity of less than three months – including repo-style transactions, money market transactions, trade finance-related transactions, and exposures arising from payment and settlement processes. When these conditions are satisfied, M may be set as low as five days for repo-style transactions and OTC derivatives exposures subject to a qualifying master netting agreement, and as low as one day for other wholesale transactions.
Question: We are unable to electronically identify small- and medium-sized enterprises (SMEs). Therefore, for any counterparty where we don't have information regarding its annual sales or assets, we will assume it doesn't qualify and input it in the Bank-Sov-Corp worksheet. Is this approach acceptable? (December 21, 2004)
Answer: Yes, that would be an acceptable approach. That said, it is important to note that QIS-4 is being conducted on a “best efforts” basis, and the agencies want institutions to apply the instructions in a manner that reflects their best judgment of the likely effects of new standards, recognizing the limitations of their systems and their knowledge of the nature of their businesses and products. If your institution has an alternative way to estimate SME exposures that you believe is sound, then you should take that approach and describe it in the questionnaire. Such techniques could, for example, be based on a sampling of portfolios based on informed discussions within your bank.
Question: Should Government National Mortgage Association (GNMA) securities be input on the Corp-Bank-Sov sheet with a probability of default (PD) of less than three basis points, or on the securitization worksheet under the ratings-based approach (RBA)? (December 21, 2004)
Answer: GNMA securities should be reported in the Corp-Bank-Sov worksheet, as stated in paragraph 53 of the QIS-4 instructions.
Question: Should foreign exchange derivative transactions with an original maturity less than or equal to 14 days be excluded from the worksheets? (December 21, 2004)
Answer: You should exclude foreign exchange derivative contracts with an original maturity of less or equal to 14 days, as you do according to current US capital adequacy guidelines.
Question: Under the Basel II rules, can collateral received from a customer be reflected in the net gross ratio? (December 21, 2004)
Answer: No, the net replacement cost to gross replacement cost ratio (NGR) should not reflect collateral received. Paragraph 87 of the QIS-4 instructions specifies that when an institution chooses to reflect collateral posted to an OTC derivative through an adjustment to the exposure at default (EAD), it should offset the current exposure and potential future exposure by the haircut value of the collateral (CA = C-C*Hc). However, as shown in the formula below, the adjustment for collateral is made after the NGR is calculated.
EAD = max {0, (CE + .4 * PFE + .6 * NGR * PFE - CA)}
where,
CE = current exposure
C = current value of collateral
CA = volatility adjusted collateral amount
Hc = haircut appropriate for the collateral type, adjusted for minimum holding period, 10 days for OTC derivatives
NGR = net replacement cost to gross replacement cost ratio
Question: As specified in paragraphs 75 and 76 of the QIS-4 instructions, banks are expected to compute capital for defaulted assets as the difference between potential loss given default (PLGD) and best estimate of expected loss (BEEL). Could you please clarify how the PLGD differs from the downturn LGD for non-defaulted assets mentioned in paragraphs 72 and 74? (December 21, 2004)
Answer: The PLGD differs from the downturn LGD in that the PLGD is estimated after default, based on the conditions prevailing at the time of actual default, while the economic downturn LGD assigned to a non-defaulted exposure is an ex-ante estimate based on its risk characteristics. The PLGD may be equal to, larger, or smaller than the economic downturn LGD. However, the PLGD should exceed the BEEL to reflect the possibility that the bank may need to recognize additional unexpected losses during the recovery period.
Question: For defaulted corporate and retail exposures, should fully charged-off loans be included? Does the treatment differ for retail and corporate exposures? (December 21, 2004)
Answer: No, fully charged-off loans should not be included. For partially charged-off loans, the exposure at default (EAD) should add back the partially charged-off amount. The treatment is the same for both retail and corporate exposures. Note that the partial charge-off amount is also added to the level of reserves for the purpose of comparing reserves to the expected loss (EL) in forming the numerator of the risk-based capital ratio.
Question: Over what time period do we include partial charge-offs? For example, is it life-to-date, year-to-date, quarter-to-date, or month-to-date? (December 21, 2004)
Answer: The correct amount of charge-off to add back in forming the exposure at default (EAD) and the level of reserves is the total amount that has been charged-off over the life of the loan.
Retail Portfolios
Question: We are planning to include our high net worth portfolio in the wholesale portfolio, as they do not meet the requirements for retail treatment. We wanted to confirm that this treatment is appropriate, as the definition of corporate in the QIS-4 instructions does not include exposures to individuals. (January 7, 2005)
Answer: In general, a bank has flexibility to classify loans to high net worth individuals as corporate or retail, based upon the unique circumstances of the transactions. However, all retail exposures -- including those to such individuals -- must meet the requirements for retail treatment, as outlined in the recently released draft retail guidance. That guidance requires: (1) the exposure to be managed on a pool basis, and (2) the obligor to be an individual, except for those qualifying as retail business exposures. Institutions should note that loans primarily secured by residential properties may be treated as residential mortgage loans, without size limit and regardless of how the funds are used. The "Other Retail" category also contains no limit on the size of the exposure, but, as with all exposures treated as retail, must meet both the "pooled" and "individual" criteria cited above. If exposures to high net worth individuals do not meet these conditions, report them as corporate exposures. Note that retail margin lending is excluded from the internal-ratings based capital requirements for QIS-4 purposes.
Question: Should we add back interest applied to principal to the loan balance of defaulted assets, as is done for partial charge-offs? (January 7, 2005)
Answer: Yes, interest applied to principal should be added back to the balance of a defaulted loan.
Question: In paragraph 107 of the QIS-4 instructions, the definition for Retail Business Exposures (RBE) includes a stipulation that the aggregate exposure per business be less than $1 million. Does "exposure" in this context refers to drawn, total commitment amount (drawn plus undrawn), or the exposure at default (EAD)? (January 7, 2005)
Answer: The correct measure for each exposure should be the total committed amount (i.e., drawn plus undrawn).
Question: Are a business owner's individual Qualifying Revolving Exposures (QRE) and Other Retail exposures intended to be included with the owner's business loans in the threshold test for classification as Retail Business Exposures (RBE)? (January 7, 2005)
Answer: QREs are included in the $1 million limit for RBE only if explicitly in the name of a business and/or originated as part of a small-business card program. Other Retail loans to individual proprietors would not be included in the $1 million limit unless they are originated through a small business program and/or clearly identified (i.e., documented as part of the approval and advance process) as being for business purposes. (Obviously, there is very substantial small-business financing in the US that takes the form of Home Equity Line of Credit (HELOC) secured by proprietors' homes and personal credit cards; however, these exposures are impossible to identify clearly and would not count towards the $1 million limit.)
Question: Would you please clarify when bank inputs that are lower than the specified floors on parameters for certain exposures are or are not overridden by these floors in the relevant formulas in the QIS-4 worksheets? Examples of floors include the three basis point floor for probability of default (PD) for all corporate, bank (including government sponsored entities), and state and local government exposures, or the 10 percent floor for loss given default (LGD) for retail mortgages. (December 21, 2004)
Answer: The Sov-Bank-Corp worksheet will not override bank inputs for either PDs or LGDs with any prescribed floors. As our instructions state, "under the advanced internal ratings-based (AIRB) approach, all corporate, bank (including government sponsored entities), and state and local government exposures are subject to a PD floor of 0.03 percent." Therefore, PDs below 0.03 percent should reflect only sovereign exposures.
The worksheets for the following portfolios will impose a 0.03 percent PD floor but will not impose an LGD floor: SME Corporate, HVCRE, IPRE, QRE, RBE and Other Retail.
For HELOCs and Other Mortgage, both a 0.03 percent floor for PDs and a 10 percent floor for LGDs will be imposed and will override any input below these levels. Nonetheless, please enter your actual LGD estimates, even if below 10 percent.
Question: Probability of default (PD) is defined differently for segments containing "fully seasoned exposures" (paragraph 114 of the QIS-4 instructions) and those containing "unseasoned loans" (paragraph 115). However, the QIS-4 instructions do not define "fully-seasoned" or "unseasoned.” Could you please provide additional information? (December 21, 2004)
Answer: Since the time profile of default can vary systematically by asset type, neither the QIS-4 instructions nor the recently released draft retail guidance put forth a prescriptive definition of "seasoned" or “unseasoned” for each asset type. Rather, each bank is expected to apply good judgment in a consistent fashion. When preparing their QIS-4 results, banks are requested to comply with the QIS-4 instructions on a “best efforts” basis. The QIS-4 questionnaire asks banks to summarize key assumptions and estimation methods underlying such “best-efforts” assessments.
Question: As specified in paragraphs 75 and 76 of the QIS-4 instructions, banks are expected to compute capital for defaulted assets as the difference between potential loss given default (PLGD) and best estimate of expected loss (BEEL). Could you please clarify how the PLGD differs from the downturn LGD for non-defaulted assets mentioned in paragraphs 72 and 74? (December 21, 2004)
Answer: The PLGD differs from the downturn LGD in that the PLGD is estimated after default, based on the conditions prevailing at the time of actual default, while the economic downturn LGD assigned to a non-defaulted exposure is an ex-ante estimate based on its risk characteristics. The PLGD may be equal to, larger, or smaller than the economic downturn LGD. However, the PLGD should exceed the BEEL to reflect the possibility that the bank may need to recognize additional unexpected losses during the recovery period.
Question: For defaulted corporate and retail exposures, should fully charged-off loans be included? Does the treatment differ for retail and corporate exposures? (December 21, 2004)
Answer: No, fully charged-off loans should not be included. For partially charged-off loans, the exposure at default (EAD) should add back the partially charged-off amount. The treatment is the same for both retail and corporate exposures. Note that the partial charge-off amount is also added to the level of reserves for the purpose of comparing reserves to the expected loss (EL) in forming the numerator of the risk-based capital ratio.
Question: Over what time period do we include partial charge-offs? For example, is it life-to-date, year-to-date, quarter-to-date, or month-to-date? (December 21, 2004)
Answer: The correct amount of charge-off to add back in forming EAD and the level of reserves is the total amount that has been charged-off over the life of the loan.
Question: Should personal lines of credit be reported on the Qualifying Revolving Exposure (QRE) worksheet or on the Other Retail worksheet? (December 21, 2004)
Answer: To qualify for reporting as a QRE, the exposure should be a revolving facility of $100,000 or less, unsecured, and unconditionally cancelable. The exposure should also meet all of the other criteria listed in the instructions for retail treatment.
Question: Are Fannie- and Freddie-guaranteed mortgages exempt from the 10 percent loss given default (LGD) floor for mortgages? (December 21, 2004)
Answer: Because Fannie and Freddie mortgage-backed securities are treated as securitizations in QIS-4, the risk weight (using the look-up table of the securitization section) would likely be 7 percent. Thus, the issue of whether or not to apply a 10 percent LGD floor generally does not arise.
Credit Risk Mitigation
Question: Where counterparties have posted financial collateral supporting over-the-counter (OTC) derivatives, can banks reflect the collateral by using either the loss given default (LGD) or exposure at default (EAD) adjustment methods? (January 24, 2005)
Answer: Yes, as explained in paragraph 85 of the QIS-4 instructions, either approach can be applied as long as the approach is consistent for all OTC derivative products.
Question: Do we need to generate our own haircuts for repo-style transactions and over the counter (OTC) derivatives to be eligible for the advanced internal-ratings based approach (A-IRB)? (January 24, 2005)
Answer: As noted in Appendix C of the QIS-4 instructions, standard supervisory haircuts are permitted, so you do not need to generate your own haircuts to be eligible for A-IRB.
Question: In what types of collateralized transactions with “core market participants” is a zero percent haircut on the collateral permitted? (December 21, 2004)
Answer: The June Mid-Year Text (MYT) offers an alternative approach for certain repo-style transactions that national supervisors may adopt at their discretion. As described in paragraphs 170 and 171 of the June MYT, for repo-style transactions that meet certain conditions and are conducted with “core market participants,” a bank may use a zero percent haircut on the collateral instead of the standard supervisory haircuts or own estimates of haircuts when calculating the exposure at default (EAD). The US agencies opted not to include this alternative approach in QIS-4.
Question: Under the Basel II rules, can collateral received from a customer be reflected in the net gross ratio? (December 21, 2004)
Answer: No, the net replacement cost to gross replacement cost ratio (NGR) should not reflect collateral received. Paragraph 87 of the QIS-4 instructions specifies that when an institution chooses to reflect collateral posted to an OTC derivative through an adjustment to the exposure at default (EAD), it should offset the current exposure and potential future exposure by the haircut value of the collateral (CA = C-C*Hc). However, as shown in the formula below, the adjustment for collateral is made after the NGR is calculated.
EAD = max {0, (CE + .4 * PFE + .6 * NGR * PFE - CA)}
where,
CE = current exposure
C = current value of collateral
CA = volatility adjusted collateral amount
Hc = haircut appropriate for the collateral type, adjusted for minimum holding period, 10 days for OTC derivatives
NGR = net replacement cost to gross replacement cost ratio
Question: How should credit derivatives held in the trading book be reported? (December 21, 2004)
Answer: The appropriate treatment is to apply the market risk approach to credit derivatives held in the trading book. In cases where the credit derivative is hedging a banking book exposure, the bank is not required to hold any counterparty credit risk capital for the credit derivative (please see question below).
Question: When a credit derivative held in the trading book is used to hedge the credit risk of a banking book exposure, is the bank required to compute the counterparty credit risk capital charge for OTC derivatives on the credit derivative? (December 21, 2004)
Answer: No, if a banking book exposure is hedged by a credit derivative, no counterparty credit risk capital is required for the credit derivative under QIS-4, regardless of whether the derivative is in the banking or trading book. Note that this treatment is different from current US capital adequacy rules, which do require a counterparty credit risk charge when the derivative is in the trading book, but not if it is held in the banking book.
Securitization Exposures
Question: On the securitization tab, how do we calculate risk-weighted assets (RWA) post credit risk mitigation (column P) for securitization exposures benefiting from guarantees? (December 21, 2004)
Answer: As per the QIS-4 instructions, use the probability of default (PD) and loss given default (LGD) of the guarantor.
Question: Question 33 of the QIS-4 questionnaire states: "for liquidity facilities to asset-backed commercial paper (ABCP) programs on an aggregate basis, what is the proportion of the total notional amount and the amount that can be drawn as of the report date?" What do you mean by "can be drawn?" Liquidity facilities to ABCP programs can have certain stipulations that must occur before they can be drawn upon, including market disruption or early amortization. As of June 30, 2004 if a liquidity facility to an ABCP program is written for a market disruption, and no market disruption occurred, does the situation qualify as "can be drawn?" (December 21, 2004)
Answer: Give us the total amount that the liquidity facility is written for (e.g., $100), the amount of assets in the conduit today (e.g., $60), and the amount of eligible assets that can be funded in the liquidity facility today (e.g., $55).
Question: In what types of collateralized transactions with “core market participants” is a zero percent haircut on the collateral permitted? (December 21, 2004)
Answer: The June Mid-Year Text (MYT) offers an alternative approach for certain repo-style transactions that national supervisors may adopt at their discretion. As described in paragraphs 170 and 171 of the June MYT, for repo-style transactions that meet certain conditions and are conducted with “core market participants,” a bank may use a zero percent haircut on the collateral instead of the standard supervisory haircuts or own estimates of haircuts when calculating the exposure at default (EAD). The US agencies opted not to include this alternative approach in QIS-4
Question: The QIS-4 instructions (paragraph 170) indicate that credit enhancing interest only (CEIOs) strips should be deducted from capital. However, paragraph 172 indicates that interest only (IO) and principal only (PO) strips should be assigned a risk-weight of 100%. Is there a reason why CEIOs would be treated differently from IOs and POs? (December 21, 2004)
Answer: Yes, IOs and POs are generally not in a subordinated position. Note the definition of the term "credit enhancing IOs". CEIOs strips are generally in a subordinated, first-loss position. For example, excess spread in a credit card securitization would meet the definition of a CEIO. In contrast, a senior, mortgage IO strip is not subordinated and would not be subject to a deduction.
Question: Should Government National Mortgage Association (GNMA) securities be input on the Corp-Bank-Sov sheet with a probability of default (PD) of less than three basis points, or on the securitization worksheet under the ratings-based approach (RBA)? (December 21, 2004)
Answer: GNMA securities should be reported in the Corp-Bank-Sov worksheet, as stated in paragraph 53 of the QIS-4 instructions.
Question: Paragraph 197 shows the formula to calculate the early amortization capital charge (i.e., EAD*KIRB*CCF). Please confirm that EAD is dollar based, KIRB is percent based, and the CCF is percent based. (December 21, 2004)
Answer: Yes, that's correct.
Question: In section D of the Securitization worksheet, we would like to confirm that the agencies want us to separate between drawn balances and undrawn exposures. For example, if a customer has a $1,000 balance/$2,500 credit limit and is expected to draw 20% of available credit line, $1,000 would fall into the drawn bucket, and $300 would fall into the undrawn bucket. Is this correct? (December 21, 2004)
Answer: Yes.
Question: When we measure the early amortization capital charge, how should we treat the accrued interest receivable (AIR) related to securitized loans? Should we include it in the risk-weighted assets (RWA) before the credit conversion factor (CCF), and then have the CCF applied to both the principal securitized loans and the AIR? (December 21, 2004)
Answer: The AIR should not be subject to the early amortization charge or the CCF accompanying such a charge since it is already being treated like a credit enhancing interest only (CEIO) strip. It should be deducted equally from Tier 1 and Tier 2 capital and does not contribute to the cap on the maximum amount of required capital for QIS-4 purposes.
Question: Are Fannie and Freddie-guaranteed mortgages exempt from the 10 percent loss given default (LGD) floor for mortgages? (December 21, 2004)
Answer: Because Fannie and Freddie mortgage-backed securities are treated as securitizations in QIS-4, the risk weight (using the look-up table of the securitization section) would likely be 7 percent. Thus, the issue of whether or not to apply a 10 percent LGD floor generally does not arise.
Equity Exposures
Question: Under current US capital adequacy guidelines, there is no explicit definition of private equity; instead, the rules refer to non-financial equity investments, as defined in FR Y-12. For QIS-4 the definition of private equity is expanded beyond the Y-12 definition and includes other types of equity positions. Consequently, the total exposure under current US capital adequacy guidelines (which is required in the Current tab of the QIS-4 template) will not match the amount required in the QIS-4 input tab. The validation check will therefore indicate "No." Should we make the exposure amount in the Current tab the same as the exposure amount in the QIS-4 Input tab? (January 24, 2005)
Answer: The amount entered into the Input sheet should reflect the broader QIS-4/Basel II definition. The amount entered into the Current worksheet should also reflect that definition, with the amounts distributed to the appropriate risk-weight buckets.
Question: Should the quarterly 99.0% loss amount under the internal models approach to equity exposures (paragraph 235 of the QIS-4 instructions) be net of an appropriate risk-free rate, as stipulated in paragraph 346 of the Mid-Year Text? (January 7, 2005)
Answer: Yes, the quarterly 99.0% loss amount should be net of an appropriate risk-free rate under the internal models approach to equities.
Question: Should non-financial equity investments currently backed out of Tier 1 capital be included in the population of equities covered under the advanced internal ratings-based (AIRB) approach to equities? If so, should either of the following adjustments be made? (1) Should we adjust Tier 1 for this current deduction prior to the 10 percent test? Or (2) should we exempt the non-financial investments and not include them in the 10 percent test, because they have already been backed out of Tier 1? (January 7, 2005)
Answer: All non-financial equity investments, such as those for which a portion are currently deducted from Tier 1, should be included in the set of equities incorporated into the AIRB approach to equities.
Banks should not adjust Tier 1 for this current deduction prior to the 10 percent test. The reason is as follows: the program (using the data provided on the "input" sheet, which are drawn from the HC-R schedule of the Y-9) has been adjusted so that it implements the "10 percent materiality test" using the measure of Tier 1 before the current regulatory treatment to make a partial deduction of equity instruments. Thus, the Tier 1 number used in QIS-4 is "gross" of (i.e., before) equity deductions. Note also that line 21of the Input sheet requests the amount of "other additions to (deductions from) Tier 1 capital." If the other deductions exceed the other additions, then that number should be negative. For QIS-4, banks should retain the sign (i.e., plus for additions, minus for deductions), so that the program will correctly add only those deductions (the negative values that represent the current capital requirements on equity positions) back to the other components of Tier 1. Once the equity deductions have been added back by the program, the materiality test and the AIRB capital measures are formed using that "corrected" value of Tier 1 capital.
The current treatment of those equity investments (i.e., their deduction from the current measure of Tier 1) does not make them "exempt" from the AIRB calculation. The only "excluded" equity investments under the AIRB approach are those related to small business investment company (SBIC) activities and community development corporation (CDC) investments (and these are risk-weighted at 100 percent or less). As noted above, because the QIS-4 program uses the measure of Tier 1 capital that is calculated "prior to" the current treatment that deducts portions of those equity exposures" all those "non-excluded" equity investments should be included in the Equity sheet.
Question: Are there differences between the QIS-4 definition of equity exposures and the current FR Y-12 (Consolidated Bank Holding Company Report of Equity Investments in Nonfinancial Companies) definition of equity investments? If so, what are the differences? (December 21, 2004)
Answer: The QIS-4 definition of equity is different than the definition used for the Y-12. For QIS-4, only mandatory convertible debt should be treated as equity, with all other convertible debt treated as debt. (In contrast, for the Y-12 report, all convertible debt is reported as equity). The other difference between the QIS-4 and Y-12 definitions is that, in QIS-4, all equity holdings, regardless of the authority under which they are held, should be included as equity, while in the Y-12, only equity investments held under the listed authorities are reported.
Question: Under the advanced internal ratings-based (A-IRB) approach to equities, may we split the "non-excluded" material exposure between the two approaches? For example, may we allocate some equities to the simple market based approach (with the 300% and 400 % risk weights) and the remaining equities to the internal models approach? (December 21, 2004)
Answer: No, for QIS-4 purposes, please report the entire non-excluded (and material) portion of the equity portfolio in either the simple approach or the internal models approach of A-IRB. If this limitation materially alters the reported results, please note this in the questionnaire.
Operational Risk
Question: We used a 99.95% confidence interval in calculating the 2005 Advanced Measurement Approach (AMA) capital charge. For QIS-4 purposes, we will try to calculate the capital charge using a 99.9% confidence interval as required in the instructions; however, in the event that it is not possible or the calculation is not entirely accurate, would it be acceptable to use the 99.95% confidence interval? (January 7, 2005)
Answer: Yes, for QIS-4 purposes, that would be fine.
Question: In the Operational Risk worksheet, would it be acceptable to calculate the exposure in cell G111 without adjustments for qualitative factors or diversification? (January 7, 2005)
Answer: Yes, for QIS-4 purposes, that would be fine
Question: What is the appropriate scope for diversification in the Operational Risk worksheet? (January 7, 2005)
Answer: For QIS-4 purposes, the scope for diversification should consider the institutions at the level used in completing the QIS-4 results.
Question: Please clarify whether the additional data requested for fraud (paragraph 245 of the QIS-4 instructions) is defined as external only or both internal and external? Also, should the fraud numbers be provided pre- or post-diversification impact? (January 7, 2005)
Answer: The fraud numbers should include both internal and external fraud, especially if the external fraud caused a loss (e.g., identity theft from an external party). Banks can provide these numbers either before or after making an adjustment for diversification; however, they should specify what they do in the questionnaire.
Question: With regards to the Total Advanced Measurement Approach (AMA) capital charge (99.9% confidence level) on the operational risk worksheet, would it be preferable for banks to use a 2005 projected number based on the proposed AMA or one for the twelve-month period used in completing the rest of the study? (December 21, 2004)
Answer: Banks should use the 2005 projected number based on the proposed AMA.
Other
Question: Where should investments in minority subsidiaries be accounted for in the QIS-4 spreadsheets? (January 24, 2005)
Answer: Investments in minority subsidiaries should be accounted for in the Input sheet, line item 115, "All other assets."
Question: Where should other assets that have not been slotted into a particular portfolio, such as asset management, be accounted for in the QIS-4 spreadsheets? (January 24, 2005)
Answer: Unlike the process for QIS-3, for QIS-4 we ask banks to incorporate 100 percent of their assets into the workbook on a best-efforts basis. For those assets that do not fall under any particular portfolio using a probability of default (PD)/loss given default (LGD) matrix, we suggest placing these exposures under the section for "Other assets not subject to the PD/LGD framework" line item "All other assets" (line 115). In response to the particular query about asset management, banks' risks associated with these activities should be incorporated into the operational risk charge (please refer to paragraph 654 of the June Mid-Year Text).
Question: For certain loan asset classes, specifically margin lending, banks mitigate credit risk by hedging the credit exposure in whole or in part by taking eligible financial collateral. For such transactions, there is little or no reliance on the obligor and no process to measure and assign a risk-rating to the obligor. The focus is on assessing the credit risk of the facility as a function of the sufficiency of the collateral. For QIS-4 purposes, will banks be required to assess probabilities of default (PDs) for each client for every facility? Will banks be required to manage these exposures on a pool basis, or can they continue to manage the exposure of the facility on a collateralized basis? (January 24, 2005)
Answer: Given the significant similarities of these types of exposures to retail margin lending, for QIS-4 purposes, please slot them on the Input sheet along with Retail Margin Loans (line 113). This approach should be taken with the understanding that this is a very low -- virtually no -- credit risk business because of the high collateralization of these exposures, much like retail margin loans. Note that for QIS-4, all exposures listed on the "Retail Margin Loans" line item receive a zero percent risk-weight under the advanced internal ratings-based approach and a 100 percent risk-weight under the current US capital adequacy rules.
Question: In the Input worksheet, there are several asset categories under "Other assets (not subject to a PD/LGD framework)" for which only a 100 percent risk-weighting is available even though there may be certain types of assets that fall into these categories that should be risk weighted by 0, 20, or 50 percent according to current US capital adequacy guidelines. For example, under the category "Accrued interest receivable and work in progress," Government Securities should be 0 percent risk weighted, Federal Funds Sold and Loans to Banks should be risk weighted at 20 percent, and accrued interest on Mortgages should be 50 percent risk weighted. Shouldn't the spreadsheet be revised to accommodate such entries? (January 24, 2005)
Answer: In order to account for instruments that should not receive a 100 percent risk-weight, we recommend that instead of providing a gross notional number, banks provide only a risk-weighted value in the appropriate cell. For example, if total accrued interest is $100, and $20 should receive a zero percent risk weight, $20 should receive a 20 percent risk weight and the remaining $60 should receive a 100 percent risk weight, banks should enter in cell E99: (0% x $20) + (20% x $20) + (100% x $60) = $64. The remaining interest ($36) would then receive a zero percent risk-weight, which banks should include in the Cash line item (cell E93). This approach should be applied to all "Other assets" that fit this category and require a risk-weight other than zero or 100 percent.
Question: Should mortgage servicing rights be treated as other assets (and risk weighted at 100 percent), as noted in section I.C. of the Advance Notice of Proposed Rulemaking? (January 7, 2005)
Answer: Yes, mortgage servicing rights should be treated as other assets with a 100% risk-weight.
Question: In the Input sheet, the line item for "All other assets" is 100 percent risk weighted under the current accord. However, there are certain assets in this category that are 0 percent risk weighted (e.g., FAS 133 adjustments), as well others with a 20 percent risk-weighting (e.g., accounts receivable from affiliate banks). Therefore, shouldn't additional cells for the 0 percent and 20 percent categories be added? (January 7, 2005)
Answer: As above, please provide a risk-weighted amount in the line item for "All other assets" (cell E115), which will be risk weighted at 100 percent and then include the remaining assets in Cash (cell E93), which will be risk weighted at 0 percent.
Question: Reverse repos are accounted for as "on-balance sheet" assets (reported under item 3b on schedule HC-Consolidated Balance Sheet of the FR Y-9C report). The Input sheet, however, appears to populate these exposures in the counterparty exposures section (cell E99). Won't this treatment cause a difference in reconciling total assets (cell E142) to the FR Y-9C report? (January 7, 2005)
Answer: Given the way that we have structured the breakdown of assets on the Input sheet, you are correct that reverse repos (despite these instruments being on balance-sheet assets) are included in the section for counterparty exposures and not in the section for on balance-sheet items. The rationale for this treatment is that, given the ability to net these exposures and use the "adjusted EAD" method, we wanted to keep repos, reverse repos, and other securities lending and borrowing transactions in the same section. We understand that cell E142 will not fully reflect all on-balance sheet items (e.g., reverse repos), but this number does not flow through to any other worksheets, and we are aware that the balance sheet total will not include these items.
Question: Would it be possible to increase the number of rows in the QIS-4 spreadsheets, so that less aggregation will be required when reporting QIS-4 results? (January 7, 2005)
Answer: No, banks should aggregate information as necessary to fit into the allotted number of rows in the spreadsheet. Having the same number of rows will greatly facilitate data aggregation and analysis by the regulatory agencies.
Question: Has the interagency QIS-4 project team developed an analysis of the differences in the data requirements between QIS-3 and QIS-4? (December 21, 2004)
Answer: The short answer is no. You should note that paragraph 4 of the QIS-4 instructions highlights some of the differences between QIS-4 and QIS-3. However, that list omits several differences, listed below:
- Loss given default (LGD). In QIS-4, banks are asked to provide a stress, ex-ante LGD for performing exposures and two versions of LGD for defaulted exposures: (a) the Best Estimate of Economic Loss (BEEL), which should reflect all partial charge-offs and also current economic conditions and the unique circumstances involving the specific exposure, and (b) the potential LGD (PLGD) that recognizes the uncertainty around the BEEL. In QIS-3, banks were only asked for a generic LGD for the portfolio. The agencies recognize that this new request is confusing and likely to be troublesome for most banks. For QIS-4 purposes, you should do your best in light of the information you have and the thrust of our request.
- Lease residuals. While covered in QIS-3, in QIS-4 the agencies ask for the exposures (in a green section) aligned by probability of default (PD) and LGD.
- Advised lines. QIS-4 asks for advised lines as a separate entry (also in green); they were conceptually taken into consideration in QIS-3 along with other potential exposures arising from commitments in deriving the exposure at default (EAD).
- Dilution risk. This is new to QIS-4.
Question: What can our bank expect in terms of feedback from the agencies after completion of QIS-4 and the submission of our results? (December 21, 2004)
Answer: It is expected that the agencies will be able to address many or most of our questions (and there may be only a few for a given institution) through phone calls, or perhaps through a discussion with on-site supervisors. QIS-4 team members will probably visit few institutions during the analysis phase of the project. To a large extent, the amount of follow-up work required will be determined by the quality and completeness of the questionnaires, and the information already available to supervisors about an institution’s risk management practices.
As you may know, after the review period and after we have developed our conclusions and reported them to our principals, we expect to hold meetings or conference calls with participants to provide them with feedback regarding the study and how their results compare generally with those of other participants (using averages or aggregates). The agencies expect this process to be similar to the feedback process in QIS-3.
Question: Did the agencies summarize key QIS-3 findings for US and non-US banks that took part in the QIS-3 exercise? (December 21, 2004)
Answer: Please refer to the Federal Reserve's web site (www.federalreserve.gov), then click "banking information," "Basel II, "Regional outreach meetings," and finally "QIS-4." The related briefing notes do not provide much detail, but they do summarize some of the findings and considerations regarding US participation in QIS-3. The web site of the Basel Committee (www.bis.org) includes a more extensive summary of the study based on worldwide data.