Barclays 2010 Annual Report Download - page 91

C. Credit risk mitigation
Barclays employs a range of techniques and strategies to actively
mitigate credit risks to which it is exposed. These can broadly be
divided into three types:
– netting and set-off;
– collateral; and
– risk transfer.
In many jurisdictions in which Barclays operates, credit risk exposures
can be reduced by applying netting and set off which uses Barclays
obligations to a counterparty to produce a lower, net, credit exposure.
This technique is commonly used in derivative transactions.
Barclays will often seek to take a security interest in a tangible or financial
asset to provide an alternative source of repayment in the event that
customers, clients or counterparties are unable to meet their obligations.
Assets taken as collateral include cash, financial assets (subject to an
appropriate margin or ‘haircut’ to reflect their price volatility) and physical
assets, particularly property but also vehicles, aircraft, ships and physical
commodities amongst many others. Assets other than cash are subject
to regular revaluation to ensure they continue to achieve appropriate
mitigation of risk. Customer agreements often include requirements
for provision of additional collateral should valuations decline or credit
exposure increase (for example due to market moves impacting a
derivative exposure).
Finally, a range of instruments including guarantees, credit insurance,
credit derivatives and securitisation can be used to transfer credit risk from
one counterparty to another. This mitigates credit risk in two main ways:
– firstly, if the risk is transferred to a counterparty which is more
creditworthy than the original counterparty, then overall credit risk
will be reduced; and
– secondly, where recourse to the first counterparty remains, a default
of both counterparties is required before a loss materialises. This will
be less likely than the default of either counterparty individually so
credit risk is reduced.
Risk transfer can also be used to reduce risk concentrations within
portfolios, lowering the impact of stress events.
D. Measurement and internal ratings
The principal objective of credit risk measurement is to produce the
most accurate possible quantitative assessment of the credit risk to which
the Group is exposed, from the level of individual facilities up to the total
portfolio. Integral to this is the calculation of internal ratings, which are
used in numerous aspects of credit risk management and in the
calculation of regulatory and economic capital. The key building blocks
of this process are:
– Probability of default (PD);
– Exposure at default (EAD); and
– Loss given default (LGD).
For example, Barclays can assign an expected loss over the next 12 months
to each customer by multiplying these three factors. We calculate probability
of default (PD) by assessing the credit quality of borrowers and other
counterparties. For the sake of illustration, suppose a customer has a
2% probability of defaulting over a 12-month period.
The exposure at default (EAD) is our estimate of what the outstanding
balance will be if the customer does default. Supposing the current
balance is £150,000, our models might predict a rise to £200,000 by then.
Should customers default, some part of the exposure is usually recovered.
The part that is not recovered, together with the economic costs
associated with the recovery process, comprise the loss given default
(LGD), which is expressed as a percentage of EAD. Supposing the LGD
in this case is estimated to be 50%, the expected loss for this customer
is: 2% x £200,000 x 50% or £2,000.
To calculate probability of default (PD), Barclays assesses the credit quality
of borrowers and other counterparties and assigns them an internal risk
rating. Multiple rating methodologies may be used to inform the overall
rating decision on individual large credits, such as internal and external
models, rating agency ratings and other market information. For smaller
credits, a single source may suffice such as the result from an internal
rating model. Barclays recognises the need for two different expressions
of PD depending on the purpose for which it is used. For the purposes
of calculating regulatory and economic capital, long-run average through-
the-cycle (TTC) PDs are required. However, for the purposes of pricing and
existing customer management, PDs should represent the best estimate
of probability of default given the current position in the credit cycle.
Hence, point-in-time (PIT) PDs are also required.
Barclays PD Masterscale
Default Probability
Default grade
TTC Band >=Min Mid <Max
10.00% 0.01% 0.02%
20.02% 0.03% 0.03%
30.03% 0.04% 0.05%
40.05% 0.08% 0.10%
50.10% 0.13% 0.15%
60.15% 0.18% 0.20%
70.20% 0.23% 0.25%
80.25% 0.28% 0.30%
90.30% 0.35% 0.40%
10 0.40% 0.45% 0.50%
11 0.50% 0.55% 0.60%
12 0.60% 0.90% 1.20%
13 1.20% 1.38% 1.55%
14 1.55% 1.85% 2.15%
15 2.15% 2.60% 3.05%
16 3.05% 3.75% 4.45%
17 4.45% 5.40% 6.35%
18 6.35% 7.50% 8.65%
19 8.65% 10.00% 11.35%
20 11.35% 15.00% 18.65%
21 18.65% 30.00% 100.00%
Barclays PLC Annual Report 2010 www.barclays.com/annualreport10 89
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