Bank of Montreal 2003 Annual Report Download - page 51

BMO Financial Group 186th Annual Report 2003 47
To ensure readiness for Basel II, BMO has established an
integrated enterprise-wide program. Leadership and oversight
are provided by a steering committee comprising senior execu-
tives from all stakeholder groups. The Basel II program leverages
existing enterprise structures for change management and
business process improvement, as well as established technology
strategies for data warehousing and knowledge management.
BMO views Basel II as an important step in the alignment of
regulatory and economic capital requirements. Furthermore, it
is consistent with both our commitment to leadership in risk
management and our strategy of continual improvement in
risk management and capital management processes.
BMO incurs credit and counterparty risk primarily in its lending
activities and, to a lesser extent, by holding investment securi-
ties. We employ comprehensive governance and management
processes surrounding credit risk activities. These include:
▪corporate policies, standards and procedures governing the
philosophy, principles and conduct of credit granting;
▪a well-developed limit-setting and monitoring process;
▪oversight by senior governance committees;
▪
independent Credit Risk Policy and Corporate Audit functions
within ERPM; and
▪a rigorous lender qualification process.
The credit granting process is well established and effective, as
evidenced by BMO’s historic loan loss experience, which com-
pares favourably to BMO’s Canadian peer group. The process
involves the use of skilled and qualified professional lenders, clear
delegation of decision-making authority, personal account ability,
specific borrower limits and account monitoring, and dynamic
portfolio management. Credit decisions are made at a manage-
ment level appropriate to the size and risk of each transaction.
Operating practices include ongoing monitoring of credit
risk exposures, regular review on an account and portfolio basis
and frequent portfolio and sector reporting to RMC and RRC. All
borrowing accounts are reviewed regularly, with most individual
commercial accounts reviewed no less than annually. Corporate
Audit reviews management processes as well as a representative
sample of lending transactions for adherence to sound lending
principles, practices, policies and procedures. In addition, BMO
carries out regular portfolio sector reviews, including compre-
hensive stress testing and scenario analysis.
BMO’s provisioning approach embodies disciplined loan
loss management and evaluation, with prompt identification of
problem loans being a key risk management objective. All prob-
lem accounts are subject to close monitoring and are reviewed
no less than quarterly.
BMO employs two key credit measures:
▪
Gross impaired loans and acceptances as a percentage of equity
and allowances for credit losses, used to assess the condition of
aportfoliobycomparing the level of impaired loans to the capi-
t al and reserves available to absorb loan losses.
▪
Provision for credit losses as a percentage of average net loans
and acceptances (including securities purchased under resale
agreements) is a measure of our credit losses occurring in the
year relative to the size of our portfolio. It is a measure of credit
quality experience.
At October 31, 2003, gross impaired loans as a percentage of
equity and allowance for credit losses was 12.15%, down 3.01
percentage points from 15.16% at October 31, 2002. Provision
for credit losses as a percentage of average net loans and accep-
tances (including securities purchased under resale agreements)
was 0.30%, down from 0.56% a year ago.
We have a well diversified portfolio, focused in North America
and comprising lending relationships with millions of clients,
the majority of them consumers and small to medium-sized
businesses. BMO’s credit risk governance policies ensure that
an acceptable level of diversification is maintained at all times.
Note 4 on page 76 of the financial statements and Tables 10
to 18 on pages 60 to 63 provide details of BMO’s loan portfolio,
impaired loans and provisions and allowances for credit losses.
Portfolio diversification is shown in the graph on page 41.
BMO utilizes various models to assess the extent and correla-
tion of risks before authorizing new exposures on large corporate
credit transactions. Expected loss (EL) and unexpected loss
(UL) are calculated for large individual transactions and for the
portfolio as a whole. The estimates of EL and UL rely upon:
▪management’s judgment;
▪probabilities of default;
Scenario analysis assists in measuring the impact of extreme,
but plausible, operational, political, economic and market events
on our operations. Scenarios may be based on historical or hypo-
thetical events, or a combination thereof. They are applied to all
significant risk-taking activities across the organization.
We also conduct ongoing industry stress tests designed to
stress BMO’s credit exposures to a specific industry or to several
industries that are highly correlated. These tests provide signifi-
cant insight into the sensitivity of our exposures to underlying
risk characteristics of the industries under review.
New Basel Capital Accord
The Basel Committee on Banking Supervision is finalizing the
development of the New Basel Capital Accord (referred to as
Basel II), which is focused on regulatory capital requirements
for credit and operational risk exposures.
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.