HSBC 2015 Annual Report Download - page 198

Report of the Directors: Risk (continued)
Appendix to Risk – Policies and practices
HSBC HOLDINGS PLC
196
Concentration of exposure
(Audited)
Concentrations of credit risk arise when a number of counterparties or exposures have comparable economic characteristics or
such counterparties are engaged in similar activities or operate in the same geographical areas or industry sectors so that their
collective ability to meet contractual obligations is uniformly affected by changes in economic, political or other conditions. We
use a number of controls and measures to minimise undue concentration of exposure in our portfolios across industry, country
and global business. These include portfolio and counterparty limits, approval and review controls, and stress testing.
Wrong-way risk occurs when a counterparty’s exposures are adversely correlated with its credit quality. There are two types of
wrong-way risk:
• general wrong-way risk occurs when the probability of counterparty default is positively correlated with general risk factors
such as, for example, where the counterparty is resident and/or incorporated in a higher-risk country and seeks to sell a
non-domestic currency in exchange for its home currency; and
• specific wrong-way risk occurs when the exposure to a particular counterparty is positively correlated with the probability
of counterparty default, such as a reverse repo on the counterparty’s own bonds. It is our policy that specific wrong-way
transactions are approved on a case-by-case basis.
We use a range of tools to monitor and control wrong-way risk, including requiring the business to obtain prior approval before
undertaking wrong-way risk transactions outside pre-agreed guidelines.
Credit quality of financial instruments
(Audited)
Our credit risk rating systems and processes differentiate exposures in order to highlight those with greater risk factors and
higher potential severity of loss. In the case of individually significant accounts that are predominantly within our wholesale
businesses, risk ratings are reviewed regularly and any amendments are implemented promptly. In our retail businesses, risk is
assessed and managed using a wide range of risk and pricing models to generate portfolio data.
Our risk rating system facilitates the internal ratings-based approach under the Basel framework adopted by the Group to
support calculation of our minimum credit regulatory capital requirement. Our credit quality classifications are defined below.
Special attention is paid to problem exposures in order to accelerate remedial action. When appropriate, our operating
companies use specialist units to provide customers with support to help them avoid default if possible.
Group and regional Credit Review and Risk Identification teams regularly review exposures and processes in order to provide
an independent, rigorous assessment of credit risk across the Group, reinforce secondary risk management controls and share
best practice. Internal audit, as a third line control function, focuses on risks with a global perspective and on the design and
effectiveness of primary and secondary controls, carrying out oversight audits via the sampling of global and regional control
frameworks, themed audits of key or emerging risks and project audits to assess major change initiatives.
The five credit quality classifications defined below each encompass a range of granular internal credit rating grades assigned
to wholesale and retail lending businesses and the external ratings attributed by external agencies to debt securities.
Credit quality classification
Debt securities
and other bills
Wholesale lending
and derivatives Retail lending
External
credit rating
Internal
credit rating
12 month
probability of
default %
Internal
credit rating1
Expected
loss %
Quality classification
Strong A
–
and above CRR21 to CRR2 0
–
0.169 EL31 to EL2 0
–
0.999
Good BBB+ to BBB– CRR3 0.170 – 0.740 EL3 1.000 – 4.999
Satisfactory BB+ to B and
unrated CRR4 to CRR5 0.741 – 4.914 EL4 to EL5 5.000 – 19.999
Sub-standard B
–
to C CRR6 to CRR8 4.915 – 99.999 EL6 to EL8 20.000
–
99.999
Impaired Default CRR9 to CRR10 100 EL9 to EL10 100+ or defaulted4
1 We observe the disclosure convention that, in addition to those classified as EL9 to EL10, retail accounts classified EL1 to EL8 that are delinquent by
90 days or more are considered impaired, unless individually they have been assessed as not impaired (see page 127, ‘Past due but not impaired gross
financial instruments’).
2 Customer risk rating.
3 Expected loss.
4 The EL percentage is derived through a combination of PD and LGD, and may exceed 100% in circumstances where the LGD is above 100% reflecting
the cost of recoveries.