ING Direct 2015 Annual Report Download - page 170

Contents
Who we are
Report of the
Management
Board
Corporate
Governance
Consolidated
annual accounts
Parent company
annual accounts
Other
information
Additional
information
Notes to the Consolidated annual accounts of ING Bank - continued
Credit risk measurement
There are two ways to measure credit risk within ING Bank’s portfolio, depending on whether the exposure is booked under an ING
office which is permitted by the ECB to use the Advanced Internal Rating Based (AIRB) approach, or if it falls under the Standardised
(SA) approach.
Standardised Approach (SA)
Unlike the AIRB approach, the standardised approach applies a fixed risk weight to each asset as dictated by the Financial Supervisory
Authorities, and is based on the exposure class to which the exposure is assigned. As such, the Standardised Approach is the least
sophisticated of the Regulatory Capital methodologies and is not as sensitive as the risk-based approach. Where external rating
agency ratings are available, they may be used as a substitute to using the fixed risk weightings assigned by the Financial Supervisory
Authorities. Because the underlying obligors are relatively small, the underlying obligors tend not to have external ratings.
Advanced Internal Rating Based Approach (AIRB)
There are five elements that drive the determination of risk weighted assets under the AIRB approach.
Probability of Default (PD): The first is the counterparty’s probability of default, which measures a counterparty’s creditworthiness in
terms of likelihood to go into default. The result of this calculation attempts to measure the senior, unsecured standalone
creditworthiness of an organisation without consideration of structural elements of the underlying transactions, such as collateral,
pricing, or maturity. Each borrower should have a rating which translates into a PD.
Exposure at Default (EAD): The second element is the counterparty’s exposure at default. These models are intended to estimate the
outstanding amount or obligation at the moment of default in the future. Since the fact that a counterparty will go into default is not
known, and the level of outstanding that may occur on that date is also not known, ING Bank uses a combination of statistical, expert
and hybrid models to estimate the Exposure at Default. With the exception of guarantees and letters of credit, the EAD is always equal
to or higher than the associated credit risk outstanding, under the assumption that counterparties tend to absorb liquidity from
available credit resources before financial problems become apparent to the counterparty’s creditors. The EAD is largely a function of
the type of credit facility (revolving, overdraft, term) offered to the borrower.
Loss Given Default (LGD): The third element is the loss given default. These models are intended to estimate the amount ING Bank will
lose when liquidating collateral pledged in association with a given loan or financial obligation, or alternatively, liquidating the
company as a whole, as part of a workout process. LGD models are based on cover types, estimated recovery rates given orderly
liquidation, and (in) direct cost of liquidation.
Maturity (M): The fourth element is the time to the maturity of the underlying financial obligation. Regulations (CRR/CRDIV) floor the
maturity element at one year and cap it at five years, despite the fact that many obligations extend their facilities for longer than five
years.
Exposure Class: The fifth element is the exposure class (a grouping of credit risks associated with a common obligor type or product
type) which is a driver for the correlation factor. To calculate risk weighted assets the default correlation between a transaction and all
other transactions in the portfolio are taken into account. The correlation factor determines which portion of the standalone risk of a
transaction is retained when the transaction is included in the portfolio and the portfolio diversification benefits are taken into
consideration.
Expected Loss (EL): The expected loss provides a measure of the value of the credit losses that ING Bank may reasonably expect to
incur on its portfolio. ING Bank must hold a reserve (as part of its capital base) to cover the expected losses in its credit portfolio. In its
basic form, the expected loss can be represented as:
EL = PD * EAD * LGD
Securitisations
ING Bank has implemented the AIRB approach for credit risk. As a consequence, ING Bank uses the Rating Based Approach (RBA) for
investments in tranches of asset-backed securities (ABS) and mortgage-backed securities (MBS) which have been rated by external
rating agencies. Rating agencies which are used by ING Bank under the RBA include: Standard & Poor’s, Fitch, Moody’s and DBRS.
Under the RBA, the RWA are determined by multiplying the amount of the exposure by the appropriate regulatory risk weights, which
depend on:
• The external rating or an available inferred rating;
• The seniority of the position;
• The granularity of the position.
ING Bank Annual Report 2015 168