Title[ Part 3: The Second Pillar - Supervisory Review Process
Section[ F. Early amortisation
801. Supervisors should review how banks internally measure, monitor, and manage risks associated with securitisations of revolving credit facilities, including an assessment of the risk and likelihood of early amortisation of such transactions. At a minimum, supervisors should ensure that banks have implemented reasonable methods for allocating economic capital against the economic substance of the credit risk arising from revolving securitisations and should expect banks to have adequate capital and liquidity contingency plans that evaluate the probability of an early amortisation occurring and address the implications of both scheduled and early amortisation. In addition, the capital contingency plan should address the possibility that the bank will face higher levels of required capital under the early amortisation Pillar 1 capital requirement.
802. Because most early amortisation triggers are tied to excess spread levels, the factors affecting these levels should be well understood, monitored, and managed, to the extent possible (see paragraphs 790 to 794 on implicit support), by the originating bank. For example, the following factors affecting excess spread should generally be considered:
w Interest payments made by borrowers on the underlying receivable balances;
w Other fees and charges to be paid by the underlying obligors (e.g. late-payment fees, cash advance fees, over-limit fees);
w Gross charge-offs;
w Principal payments;
w Recoveries on charged-off loans;
w Interchange income;
w Interest paid on investors’ certificates;
w Macroeconomic factors such as bankruptcy rates, interest rate movements, unemployment rates; etc.
803. Banks should consider the effects that changes in portfolio management or business strategies may have on the levels of excess spread and on the likelihood of an early amortisation event. For example, marketing strategies or underwriting changes that result in lower finance charges or higher charge-offs, might also lower excess spread levels and increase the likelihood of an early amortisation event.
804. Banks should use techniques such as static pool cash collections analyses and stress tests to better understand pool performance. These techniques can highlight adverse trends or potential adverse impacts. Banks should have policies in place to respond promptly to adverse or unanticipated changes. Supervisors will take appropriate action where they do not consider these policies adequate. Such action may include, but is not limited to, directing a bank to obtain a dedicated liquidity line or raising the early amortisation credit conversion factor, thus, increasing the bank’s capital requirements.
805. While the early amortisation capital charge described in Pillar 1 is meant to address potential supervisory concerns associated with an early amortisation event, such as the inability of excess spread to cover potential losses, the policies and monitoring described in this section recognise that a given level of excess spread is not, by itself, a perfect proxy for credit performance of the underlying pool of exposures. In some circumstances, for example, excess spread levels may decline so rapidly as to not provide a timely indicator of underlying credit deterioration. Further, excess spread levels may reside far above trigger levels, but still exhibit a high degree of volatility which could warrant supervisory attention. In addition, excess spread levels can fluctuate for reasons unrelated to underlying credit risk, such as a mismatch in the rate at which finance charges reprice relative to investor certificate rates. Routine fluctuations of excess spread might not generate supervisory concerns, even when they result in different capital requirements. This is particularly the case as a bank moves in or out of the first step of the early amortisation credit conversion factors. On the other hand, existing excess spread levels may be maintained by adding (or designating) an increasing number of new accounts to the master trust, an action that would tend to mask potential deterioration in a portfolio. For all of these reasons, supervisors will place particular emphasis on internal management, controls, and risk monitoring activities with respect to securitisations with early amortisation features.
806. Supervisors expect that the sophistication of a bank’s system in monitoring the likelihood and risks of an early amortisation event will be commensurate with the size and complexity of the bank’s securitisation activities that involve early amortisation provisions.
807. For controlled amortisations specifically, supervisors may also review the process by which a bank determines the minimum amortisation period required to pay down 90% of the outstanding balance at the point of early amortisation. Where a supervisor does not consider this adequate it will take appropriate action, such as increasing the conversion factor associated with a particular transaction or class of transactions.
Guidance Related to the Supervisory Review Process
(Published by the Basel Committee on Banking Supervision)
1. Core Principles for Effective Banking Supervision September 1997, Final
2. The Core Principles Methodology October 1999, Final
3. Risk Management Guidelines for Derivatives July 1994, Final
4. Framework for Internal Controls September 1998, Final
5. Sound Practices for Banks’ Interactions with Highly
Leveraged Institutions January 1999, Final
6. Enhancing Corporate Governance August 1999, Final
7. Sound Practices for Managing Liquidity February 2000, Final
8. Principles for the Management of Credit Risk September 2000, Final
9. Supervisory Guidance for Managing Settlement Risk in
Foreign Exchange Transactions September 2000, Final
10. Internal Audit in Banks and the Supervisor's Relationship with
Auditors August 2001, Final
11. Customer Due Diligence for Banks October 2001, Final
12. The Relationship Between Banking Supervisors and
Banks’ External Auditors January 2002, Final
13. Supervisory Guidance for Dealing with Weak Banks March 2002, Final
14. Sound Practices for the Management and Supervision of
Operational Risk February 2003, Final
15. Management and supervision of cross-border electronic banking
activities July 2003, Final
16. Risk management principles for electronic banking July 2003, Final
17. Principles for the management and supervision of interest rate risk July 2004, Final
18. Enhancing corporate governance for
banking organisations July 2005, For comment
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