TD Bank 2012 Annual Report Download - page 70

TD BANK GROUP ANNUAL REPORT 2012 MANAGEMENT’S DISCUSSION AND ANALYSIS68
The shaded areas of this MD&A represent a discussion on risk manage-
ment policies and procedures relating to credit, market, and liquidity
risks as required under IFRS section 7, which permits these specific
disclosures to be included in the MD&A. Therefore, the shaded areas
which include Credit Risk, Market Risk, and Liquidity Risk, form an
integral part of the audited Consolidated Financial Statements for
the years ended October 31, 2012 and 2011.
Credit Risk
Credit risk is the risk of loss if a borrower or counterparty in a transaction
fails to meet its agreed payment obligations.
Credit risk is one of the most significant and pervasive risks in
banking. Every loan, extension of credit or transaction that involves
the transfer of payments between TD and other parties or financial
institutions exposes TD to some degree of credit risk.
Our primary objective is to be methodical in our credit risk
assessment so that we can better understand, select, and manage
our exposures to reduce significant fluctuations in earnings.
Our strategy is to ensure central oversight of credit risk in each
business, reinforcing a culture of transparency, accountability,
independence, and balance.
WHO MANAGES CREDIT RISK
The responsibility for credit risk management is enterprise-wide.
To reinforce ownership of credit risk, credit risk control functions
are integrated into each business but report to Risk Management
to ensure objectivity and accountability.
Each business segment’s credit risk control unit is primarily responsible
for credit decisions and must comply with established policies, exposure
guidelines and credit approval limits, and policy/limit exception proce-
dures. It must also adhere to established standards of credit assessment
and obtain Risk Management’s approval for material credit decisions.
Risk Management provides independent oversight of credit risk by
developing centralized policies that govern and control portfolio risks
and product-specific policies as required.
The Risk Committee oversees the management of credit risk and
annually approves major credit risk policies.
HOW WE MANAGE CREDIT RISK
The Bank’s Credit Risk Management Framework outlines the internal
risk and control structure to manage credit risk and includes risk appe-
tite, policies, processes as well as limits and governance. The Credit
Risk Management Framework is maintained by Risk Management and
supports alignment with TD’s risk appetite for credit risk.
Risk Management centrally approves all credit risk policies and credit
decisioning strategies, including policy and limit exception manage-
ment guidelines, as well as the discretionary limits of officers through-
out TD for extending lines of credit.
Limits are established to monitor and control country risk, industry
risk, product, geographic and group exposure risks in the portfolios in
accordance with enterprise-wide policies.
In our retail businesses, we use approved scoring techniques and
standards in extending, monitoring and reporting personal credit.
Credit scores and decision strategies are used in the origination and
ongoing management of new and existing retail credit exposures.
The Basel II Framework
The objective of the Basel II Framework is to improve the consistency
of capital requirements internationally and make required regulatory
capital more risk-sensitive. Basel II sets out several options which repre-
sent increasingly more risk-sensitive approaches to calculating credit,
market and operational risk and risk-weighted assets (RWA). RWA are
a key determinant of our regulatory capital requirements.
Credit Risk and the Basel II Framework
We received approval from OSFI to use the Basel II Advanced Internal
Ratings Based (AIRB) Approach for credit risk, effective November 1,
2007. We use the AIRB Approach for all material portfolios, except
in the following areas:
Scoring models and decision strategies utilize a combination of
borrower attributes, including employment status, existing loan expo-
sure and performance, size of total bank relationship as well as external
data such as credit bureau scores, to determine the amount of credit we
are prepared to extend retail customers and estimate future credit
performance. Established policies and procedures are in place to govern
the use and ongoing monitoring and assessment of the performance of
scoring models and decision strategies to ensure alignment with
expected performance results. Retail credit exposures approved within
the regional credit centres are subject to ongoing Risk Management
review to assess the effectiveness of credit decisions and risk controls as
well as identify emerging or systemic issues and trends. Material policy
exceptions are tracked and reported to monitor portfolio trends and
identify potential weaknesses in underwriting guidelines and strategies.
Where unfavourable trends are identified, remedial actions are taken to
address those weaknesses.
Our Commercial Banking and Wholesale Banking businesses use
credit risk models and policies to establish borrower and facility risk
ratings, quantify and monitor the level of risk, and facilitate its
management. The businesses also use risk ratings to determine the
amount of credit exposure we are willing to extend to a particular
borrower. Management processes are used to monitor country, indus-
try, and borrower or counterparty risk ratings, which include daily,
monthly, quarterly and annual review requirements for credit expo-
sures. The key parameters used in our credit risk models are monitored
on an ongoing basis.
Unanticipated economic or political changes in a foreign country
could affect cross-border payments for goods and services, loans, divi-
dends, trade-related finance, as well as repatriation of TD’s capital in
that country. TD currently has credit exposure in a number of coun-
tries, with the majority of the exposure in North America. We measure
country risk using approved risk rating models and qualitative factors
that are also used to establish country exposure guidelines covering all
aspects of credit exposure across all businesses. Country risk ratings
are managed on an ongoing basis and are subject to a detailed review
at least annually.
As part of our credit risk strategy, we set limits on the amount of
credit we are prepared to extend to specific industry sectors. We moni-
tor our concentration to any given industry to ensure that our loan
portfolio is diversified. We manage our risk using limits based on an
internal risk rating score that combines our industry risk rating model
and detailed industry analysis and we regularly review industry risk
ratings to ensure that those ratings properly reflect the risk of the
industry. We assign a maximum exposure limit or a concentration limit
which is a percentage of our total wholesale and commercial exposure.
We also set limits on the amount of credit we are prepared to extend
to a particular entity or group of entities (also referred to as “entity risk”).
All entity risk is approved by the appropriate decision-making authority
using limits based on the entity’s borrower risk rating and for certain
portfolios, the risk rating of the industry in which the entity operates.
This exposure is monitored on a regular basis.
From time-to-time, we may use credit derivatives to mitigate industry
concentration and borrower-specific exposure as part of our portfolio
risk management techniques.
• We have approved exemptions to use the Standardized Approach
for some small credit exposures in North America. Risk Management
reconfirms annually that this approach remains appropriate.
• We have received temporary waivers to use the Standardized
Approach for our margin trading book, some small credit portfolios
and the majority of our U.S. credit portfolios. Plans are in place to
transition these portfolios to the AIRB Approach.
To continue to qualify to use the AIRB Approach for credit risk, TD must
meet the ongoing conditions and requirements established by OSFI and
the Basel II Framework. We regularly assess our compliance with the
Basel II requirements and we have sufficient resources to implement the
remaining Basel II work.