ING Direct 2013 Annual Report Download - page 263

Risk management continued ING Bank
Credit risk definitions
Credit risk is the risk of loss from the default and/or credit rating deterioration of counterparties (including bond issuers). Credit risks arise
in ING Bank’s lending, financial market and investment activities. Credit risk exposure is the total amount of outstanding plus the unused
portion of commitments. It can be measured on various levels, such as customer, legal or economic one obligor group, product, portfolio,
customer type, industry, and country. Each level can in turn be broken down from the consolidated ING Bank NV level to a local branch/
unit level. As the distribution of the exposures is of great importance in correctly managing the credit risk exposure, ING Bank has
established the credit risk appetite and concentration framework.
CRM uses risk categories to differentiate between the different types of credit risk exposures. All products within ING Bank are aggregated
to one of the following risk categories:
• Pre-settlement risk: arises when a counterparty defaults on a transaction before settlement and ING Bank has to replace the contract
by a trade with another counterparty at the then prevailing (possibly unfavourable) market price. The pre-settlement risk (potential or
expected risk) is the cost of ING Bank replacing a trade in the market. This credit risk category is associated with dealing room products
such as options, swaps, and securities financing transactions. Where there is a mutual exchange of value, the amount of credit risk
outstanding is generally based on the replacement value (mark-to-market) plus a potential future volatility concept, using a 3-7 year
historical time horizon and a 97.5% confidence level.
• Money market risk: arises when ING Bank places short-term deposits with a counterparty in order to manage excess liquidity. As
such, money market deposits tend to be short-term in nature. In the event of a counterparty default, ING Bank may lose the deposit
placed. Money market risk is measured as the notional value of the deposit, excluding any accrued and unpaid interest or the effect of
any impairment.
• Lending risk: arises when ING Bank grants a loan to a counterparty, or issues guarantees on behalf of a counterparty. This includes
term loans, mortgages, revolving credits, overdrafts, guarantees, letters of credit, etc. The risk is measured as the notional amount of
the financial obligation that the counterparty has to repay to ING Bank, excluding any accrued and unpaid interest, discount/premium
amortisations or impairments.
• Investment risk: is the credit default and risk rating migration risk that is associated with ING Bank’s investments in bonds, commercial
paper, securitisations, and other similar publicly traded securities. This can be viewed as the worst-case loss that ING Bank may incur as
a result of holding a position in underlying securities whose Issuer’s credit quality deteriorates or defaults. All investments in the banking
book are classified in the investment risk category. The primary purpose of ING Bank’s investments in the banking books is for liquidity
management.
• Settlement risk: is the risk that a counterparty will fail to deliver on financial markets (PS or MM) transaction/contract at settlement
and ING Bank could lose up to 100% of the value expected to be delivered. Settlement Risk arises when there is an exchange of value
(funds or instruments) for the same value date or different value dates and receipt is not verified or expected until after ING has given
irrevocable instructions to pay or has paid or delivered its side of the trade. The risk is that ING Bank delivers but does not receive
delivery from ING Bank’s counterparty. ING manages settlement risk in the same way as other risks including a per borrower risk limit
structure. However, because of the short term nature and per definition double count of settlement risk, ING Bank does not hold
provisions or capital for specific settlement risk. Although a relatively low risk, ING increasingly uses DVP (Delivery versus Payment) and
FITO (First in then Out) payment techniques to reduce settlement risk.
For the reconciliation between credit risk outstandings categories and financial assets we refer to the section ’Credit risk management
classification’ as included in the chapter ‘Accounting policies for the consolidated annual accounts’
Governance
CRM within ING Bank belongs to the second line of defence (the front office being the first, internal audit the third) and aligns the credit
risk taking with the strategic planning of ING Bank. It is responsible for reviewing and managing credit risk including environmental and
social risk for all types of counterparties. CRM consists of line credit risk managers who are responsible for their business lines and manage
specific portfolios and experts who support both the line credit risk manager as well as the business with tools like credit risk systems,
policies, models and reporting. To ensure the independence of the risk function the CRM General Manager is functionally responsible for
the global network of credit risk staff and the heads of the credit risk management functions for the business lines.
ING Bank’s credit policy is to maintain an internationally diversified loan and bond portfolio, while avoiding large risk concentrations. The
emphasis is on managing business developments within the business lines by means of the top-down risk appetite framework, which sets
concentration limits for countries, individual counterparties and counterparty groups and investment activities. The aim is to expand
relationship-banking activities, while maintaining stringent internal risk/reward guidelines and controls. To ensure a proper risk reward
balance in our portfolios, the risk appetite framework is linked to the MTP budget process.
Credit analysis at portfolio level is a function of different concentration levels and various metrics like Economic Capital, Regulatory Capital,
Exposure at Default, Probability of Default and Loss Given Default. The risk/reward is monitored and managed at portfolio level to ensure
efficient use of ING Bank’s capital. Credit analysis at facility level is also risk/reward-oriented in that the level of credit analysis is a function
of the risk amount, tenor, structure (e.g. covers received) of the facility, and the risks entered into. RAROC-based tools are used internally
to ensure a proper balance of risk and reward within the portfolio and concentration parameters. ING Bank’s credit analysts make use of
publicly available information in combination with in-house analysis based on information provided by the counterparty, peer group
comparisons, industry comparisons and other quantitative techniques and tools.
261ING Group Annual Report 2013
1 Who we are 2 Report of the Executive Board 3 Corporate governance 4 Consolidated annual accounts 5 Parent company annual accounts 6 Other information 7 Additional information