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Title[ Part 2: The First Pillar - Minimum Capital Requirements

Section[ 5. Corporate governance and oversight

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(i)          Corporate governance

438.     All material aspects of the rating and estimation processes must be approved by the bank’s board of directors or a designated committee thereof and senior management. ⁸⁷

These parties must possess a general understanding of the bank’s risk rating system and detailed comprehension of its associated  management reports. Senior management must provide  notice  to  the  board  of  directors  or  a  designated  committee  thereof  of  material changes or exceptions from established policies that will materially impact the operations of the bank’s rating system.

439.     Senior management also must have  a good understanding of the rating system’s design and operation, and must approve material differences between established procedure and actual practice. Management  must also ensure, on an ongoing basis, that the rating system is operating properly. Management and staff in the credit control function must meet regularly to discuss the performance of the rating process, areas needing improvement, and the status of efforts to improve previously identified deficiencies.

87   This standard refers to a management structure composed of a board of directors and senior management. The Committee is aware that there are significant differences in legislative and regulatory frameworks across countries as regards the functions of the board of directors and senior management. In some countries, the board has the main, if not exclusive, function of supervising the executive body (senior management, general management) so as to ensure that the latter fulfils its tasks. For this reason, in some cases, it is known as a supervisory board. This means that the board has no executive functions. In other countries, by contrast, the board has a broader competence in that it lays down the general framework for the management of the bank. Owing to these differences,  the notions of  the board of  directors  and senior management are used in this paper not to identify legal constructs but rather to label two decision-making functions within a bank.

440.     Internal ratings must be an essential part of the reporting to these parties. Reporting must  include  risk  profile  by  grade,  migration  across  grades,  estimation  of  the  relevant parameters per grade, and comparison of realised default rates (and LGDs and  EADs for banks on advanced approaches) against expectations. Reporting frequencies may vary with the significance and type of information and the level of the recipient.

(ii)        Credit risk control

441.     Banks must have independent credit risk control units that are responsible for the design or selection, implementation and performance of their internal rating systems. The unit(s) must be functionally independent from the personnel and  management functions responsible for originating exposures. Areas of responsibility must include:

w Testing and monitoring internal grades;

w Production  and  analysis  of  summary  reports  from  the  bank’s  rating  system,  to include historical default data sorted by rating at the time of default and one year prior to default, grade migration analyses, and monitoring of trends in key rating criteria;

w Implementing procedures to verify that rating definitions are consistently applied across departments and geographic areas;

w Reviewing  and  documenting  any  changes  to  the  rating  process,  including  the reasons for the changes; and

w Reviewing the rating criteria to evaluate if they remain predictive of risk. Changes to the rating process, criteria or individual rating parameters must be documented and retained for supervisors to review.

442.     A credit risk control unit must actively participate in the development, selection, implementation and validation of rating models. It must assume oversight and supervision responsibilities for any models used in the rating process, and ultimate responsibility for the ongoing review and alterations to rating models.

(iii)       Internal and external audit

443.     Internal audit or an equally independent function must review at least annually the bank’s rating system and its operations, including the operations of the credit function and the estimation of PDs, LGDs and EADs. Areas of review include adherence to all applicable minimum requirements. Internal audit must document its findings. Some national supervisors may also require an external audit of the bank’s rating assignment process and estimation of loss characteristics.

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