Basel introduces paper on risk assessment

The Basel Committee on Banking Supervision released last month a paper on sound credit risk assessment and valuation for loans, thus addressing how common data and processes related to loans may be used for assessing credit risk, accounting for loan impairment and determining regulatory capital requirements.

The guidance supersedes sound practices for loan accounting and disclosure, published by the committee in July 1999.

It discusses necessary processes for banks in sound credit risk assessment, valuation and control, and the responsibilities of boards of directors and senior management to maintain appropriate provisions for loan losses.

The paper also provides guidelines on how supervisors should evaluate the effectiveness of a bank’s credit risk policies and practices when assessing the appropriateness of their credit risk assessment process, loan loss provisions and regulatory capital.

It highlights provisioning concepts intended to be consistent with prudential and accounting frameworks. As noted, this supervisory guidance is not intended to set forth additional accounting requirements beyond those established by robust accounting standards.

Jaime Caruana, chairman of the Basel Committee on Banking Supervision and Governor of the Bank of Spain, said: "Sound credit risk assessment and valuation processes are essential if banks are to recognize deterioration in credit quality in an adequate and timely manner. Such thorough processes will promote more meaningful capital requirements and financial market stability."

"This paper is relevant to all banks and is more principles-based than the loan accounting guidance, which it supersedes. The practices it describes are relevant regardless of the accounting framework applied or the approach used in calculating credit risk regulatory capital requirements," Professor Arnold Schilder, member of the Basel Committee, chairman of its Accounting Task Force, and executive director at the Netherlands Bank, remarked.

The paper and summary of comments is available on the BIS website at www.bis.org.