Credit Risk Management Structure

INTRODUCTION

In April 2009, the National Monetary Council issued, through the Central Bank of Brazil, Resolution 3721, which determines the definition of the policy and the implementation of the credit risk management structure in financial institutions.

Credit risk was defined as the possibility of losses associated to the non-compliance by the borrower or counterparty with their respective financial obligations under the agreed terms, to the depreciation of the loan agreement arising from the deterioration in the borrower’s risk rating, to the reduction in gains or remuneration, to the advantages granted in renegotiation and to the recovery costs.

Banrisul’s Institutional Policy of Credit Risk Management focuses on, within the entire portfolio of credit operations, identifying, measuring, monitoring, controlling and mitigating credit risk exposure; it also intends to consolidate the culture of best credit risk management practices, to continuously improve credit risk management in all the types of assets; to monitor the appropriate levels of risk exposure to prevent unpredictable losses; to guarantee segregation of responsibilities in the credit risk management process and to participate in the evaluation and estimate of potential losses, pursuant credit risk analyses, when creating new products or reviewing current products from loan portfolio; to meet the demands of regulatory agencies in relation to the calculation and sending of relevant information related to the exposures assumed by the Bank according to credit risk’s specific legislation.

The Corporate Risk Committee is responsible for the approval of risk measuring methodologies, for ensuring the correct implementation of policies on credit risk management, for approving exposure limits in accordance to the appropriate risk levels; for notifying risk positions and capital allocation to the Board of Administration and the Board of Executive Officers, for evaluating and monitoring the Bank’s risk trends vis-à-vis the strategic objectives, ensuring alignment between them; for defining mechanisms for continuous improvement of risk awareness; for performing the strategic management of credit risk to systematically monitor delinquency levels and to propose changes, whenever necessary, in credit and risk policies and to decide on the policy for managing credit risk, practicing all acts and exercise such other powers as are conferred by the Board of Directors.

The Corporate Risk Management Unit has been defined as the area responsible for the coordination of the credit risk management process. The Control and Risk Department is the responsible area, while the Board of Administration is responsible for the information.

The representation of the credit risk management structure is as follows:

1. METHODOLOGY

1.1 CREDIT RISK MANAGAMENT

Credit risk management, intrinsic to the financial sector, is a strategic and fundamental tool for the Bank. The continuous improvement of the processes of identifying, measuring, monitoring, controlling and mitigating risks enable good governance practices aligned to the objectives, policies and strategies of the institution.

Banrisul tries to align its management activities to the standards recommended by the Basel Committee, adopting the best market practices to maximize profitability and ensure the best possible combination of asset investments and the use of required capital. The systematic improvement of risk policies, internal control systems and security rules, integrated to the Institution’s strategic and market objectives is a permanent, continuous process.

The credit risk assessment structure is based on statistical methodologies of Credit and Behavior Score and/or the principle of a technical committee decision, with the definition of credit granting scope corresponding to decision-making levels that encompass the branch network (and its various business-sized categories), the credit and risk committees located at the Head Office and also the Board of Executive Officers and the Board of Administration. This process is aimed at speeding up credit granting based on technically pre-defined limits that determine the desirable exposure that the Bank is willing to operate with each and every client, based on the risk x return ratio.

The internal policy for measuring credit risk adopted by Banrisul considers, as the base component in relation to the client, the probability of delinquency by the borrower or counterparty, with respect to their contractual obligations. This measurement of credit risk, which reflects the expected losses, is incorporated into the Bank operational management, as determined by the Regulator Agency.

The continuous and growing implementation of statistical methodologies to assess client risk, the improvement of customer segmentation, the parametrization of credit policies and business rules, combined with the optimization of controls under master file information through a certification model intensify and strengthen assessments.

The effective management of Banrisul’s credit risk exposure allows the continuous expansion of the credit portfolio, sustainably, with speed and security given the potential of the instruments used to measure the risks inherent to each client.

1.1.1 Identification and Measurement

In the process of identification and assessment of credit risk, Banrisul adopts credit scoring models and/or the principle of a technical committee decision.

The lending of credit based on scoring models (Credit Score and Behaviour Score) allows the establishment of pre-approved credit in accordance with the risk rating established in the statistical models.

The lending policies based on a committee’s decision occur by scope. The Credit Committees of the Branches can grant/refuse credit operations up to the limits of their scope, established in accordance with each branch‘s category or product. The General Management’s Credit and Risk Committees define operations and Risk Limits for clients at a decision level higher than that defined by the Branches’ Credit Committees. The Executive Board approves specific operations and Risk Limits for operations in amounts that do not exceed 3% of Shareholders’ Equity. Operations above this limit are submitted to the Board of Directors‘ appreciation.

For the Corporate segment, Banrisul adopts technical studies carried out by the internal area of risk analysis that evaluates companies from the financial, management, market and productive point of view, with periodical reviews, also observing the economic scenarios, with the insertion of the companies in these environments. The management of exposure to credit risk is based on the Institution’s selective and conservative attitude, following the strategies defined by the Board of Executive Officers and Board of Administration.

For credit operations covered or not by the scoring models are sorted in ascending order of risk, contemplating aspects in relation to the borrower and its guarantors and in relation to the operation, as required by Central Bank’s Resolution No. 2682 of December 21, 1999.

Regarding the debtor and its guarantors, are assessed: economic and financial situation, level of indebtedness, ability to generate profits, cash flow, management and control quality, timeliness and delays in payments, contingencies, economic activity sector and credit limit.

With regard to credit operations, the value, nature and purpose of the transaction, in addition to the characteristics of guarantees should be considered, particularly about the sufficiency and liquidity. Credit operations are monitored by the Credit Policy and Risk Analysis Unit to identify the minimum rating due to the higher delay. All client operations have calculated ratings, which added to the minimum, results in higher classification of risk for the customer. The rating levels are described as follows.

Bank Rating Description
1 - AA Very low risk
2 - A Low risk
3 - B Reduced risk
4 - C Moderate risk
5 - D Normal risk
6 - E Medium risk
7 - F High risk
8 - G Very high risk
9 - H Severe risk

For government securities and other debt securities, are prepared reports containing opinions of analysis for granting Operational Limits of credit risk for financial institutions and acquisitions of securities (public or private issues) issued by companies operating in the Capital Market.

The Operational Limit is the maximum value to which the Bank agrees to be exposed when purchasing bonds issued by financial institutions or non-financials and participating in Repurchase Agreements. This Operational Limit is intended both for operations involving Banrisul’s Treasury, through the Financial Unit, and to operations involving the allocation of third-party funds through participation in Banrisul’s investment funds managed by the Third Party Fund Management Unit.

The extent of the technical analysis comprises the economic-financial aspect of the counterparty; economic environment; profile of the company and its controllers; study of the conglomerate; and external rating of the counterparty. Financial statements may be reclassified in accordance with criteria which allow the systematic determination of the positions of assets, liabilities and results, to survey indicators needed for further weighting of the limits.

For operations with Derivative Financial Instruments (DFI) is provided to counterparties not to require guarantee for the operation up to a certain value, thus creating an exposure to credit risk. In this case, there is a need to establish an Operational Limit to which the exposure will be uncovered, ie for which it will not have constitution of guarantee margin. Up to the Operating Limit is not necessary to provide guarantee margin, however, once exceeded, it will occur margin call by the end winning part (buyers priced below and sellers priced above the price adjustment), and the losing counterparty (sellers priced below and buyers priced above the price adjustment) having to offer a guarantee.

1.1.2 Monitoring

In the monitoring stage, credit and behavior scores analyses are carried out to set the desired parameters, through the use of statistical validation techniques. The analyses are reviewed on a six-monthly basis by the Management Committees and the Board of Executive Officers.

For all clients’ segments, default indicators, past due, and volume analyses are performed in several layers and groupings, enabling the management and the monitoring of such exposures by product, risk classification, credit concentration, branch and others.

These analyses, conducted periodically, aim to monitor credit risk and the Bank’s commercial credit performance, ensuring compatibility with market trends, ensure compliance with the guidelines, minimizing the risk of disconnection between decision and execution.

Consolidated analyses with proposed adjustments to existing policies, if necessary, in accordance with the responsibilities of the component bodies, are assessed each month by the decision-making bodies and the Executive Board.

Still, management reports of the Bank’s credit portfolio are elaborated for monitoring, by the branch network, of the applied volumes and the default ratios.

In addition, monitoring is performed from the exposure to the risk of the credit portfolio as for its representativeness compared to the Required Reference Equity of the Institution, as well as the impacts of legislation and/or adopted policies. The analyses based on information from the Statement of Operational Limits are assessed periodically by the Management Committees and Board of Executive Officers.

To deal with the doubtful accounts it is recognized on a monthly the provision, basis in accordance with Resolution 2689/99 of the Central Bank.

The exposures to counterparty credit risk of Derivative Instruments are monitored periodically, with evaluation of the margin calls from counterparties, and of the Operating Limits in effect, to report quarterly to the Management Committees.

Still in this stage, stress tests are performed in the Loan Portfolio in order to estimate the required capital and the impact of additional provisions in the Basel Ratio in situations of adverse scenarios, where there might be deterioration of the portfolio of the Institution.

1.1.3 Control and Mitigation

The monitoring of the credit portfolio through management tools is directly related to the controlling and mitigation of credit risk, to try and set identifiable behaviors that require further intervention.

Exposure to the credit risk is mitigated through the structuring of guarantees and pricing, appropriate to the level of risk to be incurred due to the characteristics of the borrower and of the operation at the moment of granting. In the pricing of the retail segment is considered the delinquency product to debug the rate and find out the waste. In the Corporate segment, the pricing Business Bureau considers the rating of the customer.

The Bank manages, limits and controls concentrations of credit risk. Among the procedures adopted, can be highlighted:

  • Management structures the levels of risk assumed by establishing limits on the extent of risk acceptable in relation to a specific borrower, or groups of borrowers and industry segments. These risks are monitored on a rotating basis and are subject to revisions annually or more frequently, when needed. The limits on the level of credit risk by product and industry sector are approved by the Executive Board and the Board of Directors, if applicable;
  • Exposure to any borrower, including financial agents, in the case of counterparties, is additionally restricted by sub-limits that cover exposure registered and not registered in the balance sheet. Real exposures in accordance with the established limits are controlled on a monthly basis;
  • Exposure to credit risk is also managed through the regular analysis of borrowers, actual and potential, with respect to principal and interest payments and changes of the registration status and of their limits when appropriate;

The Bank implements guidelines and policies already consolidated on the acceptance of specific types of guarantee or risk mitigation, established in contracts for loans or financing, such as the right to sell or re-submit a guarantee in the case of non-compliance by the debtor of its obligations, the same being assessed and analyzed at the time of granting credit. For guarantees of receivables is observed selectivity, concentration and validation of drawn and other parameters of the credit policy for the product and its guarantee.

The maximum exposure to credit risk corresponds to the full amount of the commitment established between the parties. Still, it is worth noting that Banrisul controls all the guarantees contracted, especially for operations with a mitigator of debt security guarantees, managing them throughout the entire progress of the operation, recovering the guarantee whenever necessary during the operation/contract and writing-off the surplus at the end.

Banrisul employs guarantees against the release of funds as one of the measures to mitigate credit risk, a traditional and customary practice in the financial market. Usually, for such control, the Bank has admitted receiving real and personal guarantees in accordance with the particular characteristics of each contract and credit line.

In cases involving the execution of guarantees linked to a contract in default, the Bank seizes the assets guaranteed by the counterparty and subsequently sells them in auctions, in compliance with the terms determined by the Central Bank of Brazil. They are also accounted for under the Special Regime, in accordance with the definitions established in the Accounting Plan of National Financial System Institutions - Cosif.

Exceptionally, the guarantee may be considered difficult to monetize. This considers contingencies that prevent the realization of this guarantee, such as natural phenomena, obsolescence and/or deterioration of these assets, making their market liquidity unfeasible.

In relation to transactions involving Derivative Financial Instruments, Banrisul participates in the swap modality, recorded in balance sheet and compensation accounts, which are designed to meet its own needs for managing its global exposure. The use of DFI is aimed, predominantly, to mitigate risks arising from currency fluctuations of the external funding operation performed by Banrisul, resulting in the conversion of these rates to the variation of the CDI rate.

2. REQUIRED CAPITAL AND ADOPTED MODEL

Banrisul adopts, for calculating the share of risk-weighted assets (RWA) regarding exposure to credit risk subject to the calculation of capital requirement, the standardized approach (RWAcpad), as established by Circular No. 3,644 of March 4, 2013, published by the Central Bank.

The methodology establishes that the capital to be allocated to credit risk should be calculated considering the incidence on the exposures defined by the Circular Letters and Announcements, encompassing the investment of financial resources in assets and rights or the expense recorded in assets, credit commitments, releasable credits, provision of guarantees and future gains arising from operations with Derivative Financial Instruments, including swap and term operations, weighted by risk factors.