HSBC 2007 Annual Report Download - page 203

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Credit quality of loans and advances
(Audited)
HSBC’s credit risk rating systems and processes
differentiate exposures in order to highlight those
with greater risk factors and higher potential severity
of loss. For individually significant accounts, risk
ratings are reviewed regularly and amendments,
where necessary, are implemented promptly. Within
the Group’s retail portfolios, risk is assessed and
managed using a wide range of risk and pricing
models.
For many years, HSBC has deployed a seven-
grade rating system based on a ‘composite’
assessment of the likelihood and extent of
delinquency and risk mitigation (for details,
see page 224).
This legacy risk rating scale is being superseded
by a more sophisticated and granular methodology,
based on probability of default and loss estimates,
compliant with an internal ratings-based (‘IRB’)
approach required to support the Basel II framework
for calculating the Group’s minimum capital
requirement. The integration of this framework into
reporting structures will enable Board and regulatory
reporting on the new basis in accordance with the
Group’s IRB obligations. The new framework is
well embedded in the Group’s principal operating
entities.
Impairment assessment
(Audited)
When impairment losses occur, HSBC reduces the
carrying amount of loans and advances and held-to-
maturity financial investments through the use of an
allowance account. When impairment of available-
for-sale financial assets occurs, the carrying amount
of the asset is reduced directly.
Two types of impairment allowance are in place:
individually assessed and collectively assessed, as
discussed below.
Impairment allowances may be assessed and
created either for individually significant accounts
or, on a collective basis, for groups of individually
significant accounts for which no evidence of
impairment has been individually identified or for
high-volume groups of homogeneous loans that are
not considered individually significant.
It is HSBC’s policy that each operating
company creates allowances for impaired loans
promptly and on a consistent basis.
Management regularly evaluates the adequacy
of the established allowances for impaired loans by
conducting a detailed review of the loan portfolio,
comparing performance and delinquency statistics
with historical trends and assessing the impact of
current economic conditions.
Individually assessed impairment allowances
These are determined by evaluating exposure to loss,
case by case, on all individually significant accounts
and all other accounts that do not qualify for the
collective assessment approach outlined below.
Loans are treated as impaired as soon as there is
objective evidence that an impairment loss has been
incurred. The criteria used by HSBC to determine
that there is such objective evidence include,
inter alia:
• known cash flow difficulties experienced by the
borrower;
• past due contractual payments of either principal
or interest;
• breach of loan covenants or conditions;
• the probability that the borrower will enter
bankruptcy or other financial realisation; and
• a significant downgrading in credit rating by an
external credit rating agency.
In determining the level of allowances on such
accounts, the following factors are typically
considered:
• HSBC’s aggregate exposure to the customer;
• the viability of the customer’s business model
and their capacity to trade successfully out of
financial difficulties, generating sufficient cash
flow to service debt obligations;
• the ability of the borrower to obtain, and make
payments in, the currency of the loan if not
denominated in local currency;
• the amount and timing of expected receipts and
recoveries;
• the extent of other creditors’ commitments
ranking ahead of, or pari passu with, HSBC and
the likelihood of other creditors continuing to
support the company;
• the complexity of determining the aggregate
amount and ranking of all creditor claims and
the extent to which legal and insurance
uncertainties are evident;
• the value of security and likelihood of
successfully realising it;
• the existence of other credit mitigants and the
ability of the providers of such credit mitigants
to deliver as contractually committed; and