Bank of Montreal 2014 Annual Report Download - page 127

Notes
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
We strive to limit credit risk by dealing only with counterparties that
we believe are creditworthy, and we manage our credit risk for other
credit instruments using the same credit risk process that is applied to
loans and other credit assets.
Summarized information related to various commitments is as
follows:
(Canadian $ in millions) 2014 2013
Contractual
amount
Contractual
amount
Credit Instruments
Standby letters of credit and guarantees 13,949 13,470
Securities lending 4,872 3,772
Documentary and commercial letters of credit 1,111 1,205
Commitments to extend credit (1)
– Original maturity of one year and under 16,752 13,616
– Original maturity of over one year 68,507 58,244
Total 105,191 90,307
(1) Commitments to extend credit exclude personal lines of credit and credit card lines of credit
that are unconditionally cancellable at our discretion.
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
Credit and counterparty risk is the potential for loss due to the failure of
a borrower, endorser, guarantor or counterparty to repay a loan or
honour another predetermined financial obligation. 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 84 to 86 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 within the individual
sector in the following table, comprising $169.0 billion ($181.6 billion in
2013). 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.
140 BMO Financial Group 197th Annual Report 2014