Barclays 2007 Annual Report Download - page 244

Notes to the accounts
For the year ended 31st December 2007
242 Barclays PLC Annual Report 2007
47 Credit risk (continued)
Settlement risk
The Group is exposed to settlement risk in its dealings with market counterparties (predominantly other financial institutions). These risks arise, for
example, in foreign exchange transactions when Barclays pays away its side of the transaction to another bank or other counterparty before receiving
payment from the other side. The risk is that the counterparty may not meet its obligation. It also arises on derivative contracts where the carrying value of
the financial asset is related to the credit condition of the counterparty.
Settlement risk also arises through the operation of a number of systems through which Barclays makes and receives payments on behalf of its customers.
While these exposures are of short duration, they can be large. In recent years, settlement risk has been reduced by several industry initiatives that have
enabled simultaneous and final settlement of transactions to be made (such as payment-versus-payment through Continuous Linked Settlement and
delivery-versus-payment in central bank money).
Barclays has worked with its peers in the development of these arrangements. Increasingly the majority of high value transactions are settled by such
mechanisms. Where these mechanisms are not available, the risk is further reduced by dealing predominantly with highly-rated counterparties, holding
collateral and limiting the size of the exposures according to the rating of the counterparty, with smaller exposures to those of higher risk.
Country risk
Credit risk is manifested as country risk where difficulties may arise in the country in which the exposure is domiciled, thus impeding or reducing the value
of the asset, or where the counterparty is the country itself.
Barclays manages country risk by setting a country risk appetite, which is known as the Country Guideline and agreed at the Group Credit Committee. All
cross-border or domestic foreign currency transactions are aggregated to give the current utilisation, in terms of country loss given default (CLGD),
against country appetite. The level of CLGD incurred by a counterparty transaction will largely depend on three main factors: the country severity, the
product severity and counterparty grade. The calculation and loss given default is described under ‘Credit Risk measurement’ below.
CLGD is incurred in the country of direct risk, defined as where the majority of operating assets are held. This may differ from the country of incorporation.
However, where transactions are secured with collateral, the country risk can be transferred from the country of the borrower to the country of the
collateral provider. This is only permitted where the collateral definitely covers the borrowing and is not expected to decrease over time.
Credit risk measurement
Barclays uses statistical modelling techniques throughout its business in its credit rating systems. These systems assist the Bank in frontline credit
decisions on new commitments and in managing the portfolio of existing exposures. They enable a coherent approach to risk measurement across all
credit exposures, retail and wholesale. The key building blocks in the measurement system are the probability of customer default (PD), exposure in the
event of default (EAD), and severity of loss-given-default (LGD). Using these, Barclays builds the analyses that lead to its decision support systems in the
Risk Appetite context described previously.
Where financial models are used to monitor credit risk, they are based upon customers’ personal and financial performance information over recent
periods as a predictor for future performance. The models are reviewed regularly to monitor their robustness relative to actual performance and amended
as necessary to optimise their effectiveness.
For corporate and wholesale customers, Barclays also assesses the credit quality of borrowers and other counterparties and assigns them an internal risk
rating. There are two different categories of default rating used. The first reflects the statistical probability of a customer in a rating class defaulting within
the next 12-month period, and is referred to as a point in time rating (PIT). The second also reflects the statistical probability of a customer in a rating class
defaulting, but the period of assessment is 12 months of average credit conditions for the customer type. This type of rating therefore provides a measure
of risk that is independent of the current credit conditions for a particular customer type, is much more stable over time than a PIT rating and is referred to
as a through the cycle (TTC) rating.
Country risk grades are assigned to all countries where the Group has, or is likely to have, exposure and are reviewed every quarter to ensure they remain
appropriate. Country grades, which are derived from long-term sovereign foreign currency ratings, range from 1 (lowest probability of default) to 21
(highest probability of default). A ceiling is applied where a country is graded 12 or lower so that the counterparty cannot be graded higher than the
country, unless some form of protection is available in the event of a cross-border event, such as a significant portion of a counterparty’s assets or income
being held or generated in a convertible currency.
As noted above, for listed debt securities, the Group has regard to both external credit ratings and internal default grades where such ratings are not
available or current.
Multiple rating methodologies may be used to inform the rating decision on individual large credits, such as internal and external models, rating agency
grades and, for wholesale assets, market information such as credit spreads. For smaller credits, a single source may suffice, such as the result from a
rating model.
For debt securities and counterparties where third party ratings are used to inform credit decisions, the Group mainly uses those provided by Standards
and Poors’ or Moody’s.
Barclays wholesale credit rating contains 21 grades, representing the Group’s best estimate of credit risk for a counterparty based on current economic
conditions.
Retail customers are not assigned internal risk ratings in this way for account management purposes, although a mapping of the PIT probability of default
to one of eight Barclays Retail Grades (BRG) is used for some internal reporting purposes.
The tables below detail how external rating grades, Default Grades and Barclays Retail Grades relate to the categories of credit quality selected for the
financial statements. Where applicable, the internal measure of probability of default has been presented for indicative purposes.