Bank of Montreal 2013 Annual Report Download - page 131

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
Note 6: Risk Management
We have an enterprise-wide approach to the identification,
measurement, monitoring and management of risks faced across the
organization. The key risks related to our financial instruments are
classified as credit and counterparty, market, and liquidity and
funding risk.
Credit and Counterparty Risk
We are exposed to credit risk arising from the possibility that
counterparties may default on their financial obligations to us. Credit risk
arises predominantly with respect to loans, over-the-counter derivatives
and other credit instruments. This is the most significant measurable risk
that we face. Our risk management practices and key measures are
disclosed in the text and tables presented in a blue-tinted font in
Management’s Discussion and Analysis on pages 83 to 84 of this report.
Additional information on loans and derivative-related credit risk is
disclosed in Notes 4 and 10, respectively.
Concentrations of Credit and Counterparty Risk
Concentrations of credit risk exist if a number of clients are engaged in
similar activities, are located in the same geographic region or have
similar economic characteristics such that their ability to meet
contractual obligations could be similarly affected by changes in
economic, political or other conditions. Concentrations of credit risk
indicate a related sensitivity of our performance to developments
affecting a particular counterparty, industry or geographic location. At
year end, our credit assets consisted of a well-diversified portfolio
representing millions of clients, the majority of them consumers and
small to medium-sized businesses.
From an industry viewpoint, our most significant exposure as at
year end was to individual consumers, captured in the “individual”
sector, comprising $181.6 billion ($177.6 billion in 2012). Additional
information on the composition of our loans and derivatives exposure is
disclosed in Notes 4 and 10, respectively.
Basel III Framework
We use the Basel III Framework as our capital management framework.
We use the Advanced Internal Ratings Based (“AIRB”) approach to
determine credit risk-weighted assets in our portfolio except for
acquired loans in our M&I and other select portfolios, for which we use
the Standardized Approach. The framework uses exposure at default to
assess credit and counterparty risk. Exposures are classified as follows:
‰ Drawn loans include loans, acceptances, deposits with regulated
financial institutions, and certain securities. Exposure at default
(“EAD”) represents an estimate of the outstanding amount of a credit
exposure at the time a default may occur. For off-balance sheet
amounts and undrawn amounts, EAD includes an estimate of any
further amounts that may be drawn at the time of default.
‰ Undrawn commitments cover all unutilized authorizations, including
those which are unconditionally cancellable. EAD for undrawn
commitments is model generated based on internal empirical data.
‰ Over-the-counter (“OTC”) derivatives are those in our proprietary
accounts that attract credit risk in addition to market risk. EAD for OTC
derivatives is equal to the net gross replacement cost plus any
potential credit exposure amount.
‰ Other off-balance sheet exposures include items such as guarantees,
standby letters of credit and documentary credits. EAD for other off-
balance sheet items is based on management’s best estimate.
‰ Repo-style transactions include repos, reverse repos and securities
lending transactions, which represent both asset and liability
exposures. EAD for repo-style transactions is the total amount drawn,
adding back any write-offs.
‰ Adjusted EAD represents exposures that have been redistributed to a
more favourable probability of default band or a different Basel asset
class as a result of applying credit risk mitigation.
Total non-trading exposure at default by industry sector, as at October 31, 2013 and 2012, based on the Basel III classifications are as follows:
Commitments Other off-balance
(Canadian $ in millions) Drawn (undrawn) OTC derivatives sheet items Repo-style transactions Total
2013 2012 2013 2012 2013 2012 2013 2012 2013 2012 2013 2012
Financial institutions 60,448 46,398 12,693 10,887 – 104 2,978 2,544 27,515 55,471 103,634 115,404
Governments 43,142 44,190 1,581 1,292 – – 1,333 1,002 9,503 14,537 55,559 61,021
Manufacturing 11,617 10,053 9,125 5,502 14 20 1,061 941 – – 21,817 16,516
Real estate 18,532 17,462 4,639 2,094 – 1 1,122 762 – – 24,293 20,319
Retail trade 9,394 8,666 4,675 3,396 – 1 532 463 – – 14,601 12,526
Service industries 22,999 19,483 8,161 5,293 6 29 3,547 2,558 – 949 34,713 28,312
Wholesale trade 7,465 8,554 3,927 3,738 – 7 365 1,370 – – 11,757 13,669
Oil and gas 3,831 3,492 5,807 4,801 – – 401 189 – – 10,039 8,482
Individual 139,905 130,385 41,576 47,166 – – 67 40 – 21 181,548 177,612
Others (1) 33,028 28,515 13,370 10,274 3 4 3,270 2,980 – 34 49,671 41,807
Total exposure at
default 350,361 317,198 105,554 94,443 23 166 14,676 12,849 37,018 71,012 507,632 495,668
Notes
(1) Includes industries having a total exposure of less than 2%.
Additional information about our credit risk exposure by geographic region and product category for loans, including customers’ liability under
acceptances, is provided in Note 4.
Credit Quality
We assign risk ratings based on probabilities as to whether Based on the Basel III classifications, the following tables present
counterparties will default on their financial obligations to us. Our our retail and wholesale credit exposure by risk rating on an adjusted
process for assigning risk ratings is discussed in the text presented in a exposure at default basis as at October 31, 2013 and 2012. Wholesale
blue-tinted font in the Enterprise-Wide Risk Management section of includes all loans that are not classified as retail.
Management’s Discussion and Analysis on page 83 of this report.
142 BMO Financial Group 196th Annual Report 2013