1. DIFFERENT APPROACHES FOR CREDIT RISK CONTROL AND LOAN LOSS PROVISIONING THE SPANISH EXPERIENCE Javier de la Cruz Bucharest, April 2007

2. FINANCIAL INFORMATION FLOWS

3. FINANCIAL INFORMATION SHAREHOLDERS SUPERVISORS FINANCIAL MARKETS COSTUMERS TAX AUTHORITIES STATISTICAL REQUIREMENTS INVESTORS MANAGERS CRAs FINANCIAL ANALYSTS MEDIA... BANKING SUPERVISORS SECURITIES SUPERVISORS NATIONAL REGIONAL. LOCAL... CENTRAL BANK & NATIONAL INTERNA TIONAL MIS BUDGETS, MARKETING,... PUBLIC REGISTERS LEGAL INFORM. CCR

4. FINANCIAL INFORMATION FLOWS FINANCIAL INFORMATION SHAREHOLDERS SUPERVISORS FINANCIAL MARKETS COSTUMERS TAX AUTHORITIES STATISTICAL REQUIREMENTS INVESTORS MANAGERS CRAs FINANCIAL ANALYSTS MEDIA... BANKING SUPERVISORS SECURITIES SUPERVISORS NATIONAL REGIONAL. LOCAL... CENTRAL BANK & NATIONAL INTERNA TIONAL MIS BUDGETS, MARKETING,... PUBLIC REGISTERS LEGAL INFORM. CCR FINANCIAL GROUPS INTERNATIONAL ACTIVITIES CONSOLIDATION DIFFERENT COUNTRIES

5. FINANCIAL INFORMATION FLOWS There are many information users with different needs, so there must be different and specific information flows, regardless of convergence efforts.

6. FINANCIAL INFORMATION GENERATION

7. TRADITIONAL APPROACH ACCOUNTING FINANCIAL STATEMENTS FINANCIAL INFORMATION TRANSFORMATION INTERNAL SECTOR PUBLIC SECTOR PRIVATE SECTOR BUSINESS OPERATIONS

8. FINANCIAL INFORMATION GENERATION MODERN APPROACH INTERNAL SECTOR PUBLIC SECTOR PRIVATE SECTOR BUSINESS OPERATIONS DATABASESAPPLICATIONS PRINCIPLES & PARAMETERS

9. FINANCIAL INFORMATION GENERATION Information must be stored with a business perspective, IT allows to easily prepare reports in quite different ways, according to what is needed in each case.

10. CREDIT RISK

11. TRADITIONAL APPROACH RISK MUST BE REDUCED OR ELIMINATED LENDING BASED ON EXPERIENCE AND COLLATERAL LOAN LOSSES ARE A NEGATIVE SURPRISE RISK IS A NEGATIVE ELEMENT LOAN LOSS PROVISIONING IS MADE CASE BY CASE SPECIFIC PROVISIONS EX POST PROVISIONS CONSERVATIVE APPROACH GENERIC PROVISIONS EX ANTE PROVISIONS HIDDEN RESERVES CLOSE TO CAPITAL

12. CREDIT RISK MODERN APPROACH RISK MUST BE CONTROLLED AND MANAGED CREDITS GRANTED ON CREDIT RISK EVALUATION LOAN LOSSES ARE INCORPORATED TO INTEREST RATES PRICING RISK IS PART OF THE BUSINESS GENERIC PROVISIONS STATISTICAL PROVIONS SPECIFIC PROVISIONS CAPITAL EX ANTE ESTIMATION EX POST ESTIMATION UNEXPECTED LOSS EXPECTED LOSS CONFIRMED LOSS STATISTICAL PROVISIONS LOAN LOSS PROVISIONING SPECIFIC PROVISIONS REAL LOSS GENERIC PROVISIONS SOLVENCY UNEXPECTED LOSS CAPITAL REQUIREMENTS INTERNAL MODELS PD & LGD & EL & UL ELLGD UL “ANTICYCLICAL PROVISIONS”

13. CREDIT RISK Credit Risk Control and Management has significantly improved and this must be recognised from all the relevant perspectives.

14. ACCOUNTING AND SUPERVISORY APPROACHES

15. ACCOUNTING APPROACH REAL LOSSESLOAN LOSS PROVISIONING CASE BY CASE ESTIMATIONS PORTFOLIO ESTIMATIONS SUPERVISORY APPROACH EXPECTED LOSSES LOAN LOSS PROVISIONINGPDLGD INTERNATIONAL STANDARDS ACCOUNTING SUPERVISION IAS BASEL FORWARD LOOKING POLICY EFFECTS EFFECTIVE INT. RATES CAPITAL STANDARDS SETTER?

16. ACCOUNTING AND SUPERVISORY APPROACHES Accounting and supervisory approaches are evolving and converging on an international basis in a parallel way, although there is still a clear need for mutual understanding, ON AN INTERNATIONAL BASIS AND UNDER MODERN RISK CONTROL AND MANAGEMENT FRAMEWORKS.

17. TAXATION APPROACH

18. TRADITIONAL APPROACH FINANCIAL STATEMENTS TAX FORMS TAXES ARE A % OF PROFITS HIGHER PROVISIONS = LOWER TAXES INCENTIVES FOR LOWER PROVISIONS FINANCIAL INFORMATION IS AN INSTRUMENT, NOT THE TARGET FISCAL POLICIES TAXES = INCENTIVES FOR HIGHER PROVISIONS IMAGE = INCENTIVES FOR LOWER PROVISIONS TAXES = INCENTIVES FOR HIGHER PROVISIONS SOLVENCY = INCENTIVES FOR HIGHER PROVISIONS BALANCE OF POWER SUPERVISORY PROVISIONS PROVISION CAPS TAX PROVISIONS

19. TAXATION APPROACH MODERN APPROACH FINANCIAL STATEMENTS PROFIT AND LOSSTAXES FISCAL POLICIES ADJUSTMENTS TO TAXES, NOT TO PROFITS TECHNICAL CRITERIA FINANCIAL INFORMATION BALANCE OF POWER DEFERRED & ANTICIPATED TAXES

20. TAXATION APPROACH Tax issues should no longer directly influence financial information. Taxation should begin where profits and losses are technically determined.

21. THE SPANISH EXPERIENCE

22. EARLY 1980´s DEFAULT EVENTS OBJECTIVE EVENTS (TIME) NON-PERFORMING LOANS SUBJECTIVE EVENTS (FINANCIAL CONDITION) COLLATERAL & GUARANTEES ASSETS CLASSES ELAPSED TIME SPECIFIC PROVISIONS AS % OF LOANS NON-PERFORMING DEBTORS TYPE OF LENDING SHORT AND LONG TABLES

23. PAST DUE CRITICAL SITUATION...MINIMUMMATURITYMAXIMUM... TECHNICAL DELAY OBJECTIVE DETERIORATION DEFAULTED DEBTWRITE-OFF SIGNIFICANT DELAY HIGH RECOVERY DECREASING RECOVERY MARGINAL RECOVERY NO PROVISIONS INCREASING PROVISIONS (FROM 25% TO 100%) WRITE-OFF NON-ACCRUAL BASIS??? RECOVERIES = EXTR. ITEMS OBJECTIVE APPROACH

24. DOUBTFUL CRITICAL SITUATION...MINIMUMMATURITYMAXIMUM... EVALUATION OF TIME & FINANCIAL CONDITION PAST DUE/DOUBTFULWRITE-OFF SERIOUS CONCERN ABOUT REGULAR PAYMENT SIGNIFICANT LOSS DECREASING RECOVERY MARGINAL RECOVERY MINIMUM PROVISIONS (10% - 25%) INCREASING PROVISIONS (FROM 25% TO 100%) WRITE-ÓFF NON-ACCRUAL BASIS RECOVERIES = EXTR. ITEMS SUBJECTIVE APPROACH

25. THE SPANISH EXPERIENCE LATE 1990´s STATISTICAL PROVISIONS CREDIT RISK NTERNAL MODELS HISTORICAL PROJECTIONS QUALITATIVE ASPECTS LATE 1980´s HIGH PROFITS CYCLE CONCERNS EARLY 1980´s SPECIFIC PROVISIONS HIDDEN RESERVES FOR EXTREME LOSSES GENERIC PROVISIONS CREDIT RISK CONTROL RISK CONTROL INCENTIVES MORE ACCURATE EVALUATION STOCK FLOW

26. CONVERGENCE AND CHALLENGES EARLY 2000´s BASEL BANKING APPROACH IAS “PUBLIC” COMPANIES APPROACH INTERNATIONAL CONVERGENCE NATIONAL STANDARDS SETTER? INTERNATIONAL CONVERGENCE CAPITAL EUROPEAN UNION EUROPEAN UNION BIS MEMBER UNEXPECTED LOSS EXPECTED LOSS LOAN LOSS PROVISIONING FOR “PUBLIC” COMPANIES INTERNAL MODELS GENERIC & SPECIFIC PROVISIONS

27. LOAN LOSS PROVISIONING LOAN LOSS PROVISIONS GENERIC PROVSIONS SPECIFIC PROVSSIONS  “OLD GENERIC”  “OLD STATISTICAL” SUBSTANDARD PAST DUE 5 CALENDARS DOUBTFUL STOCK UL FLOW EL INTERNAL MODELS INDIVIDUAL ANALYSIS COLLECTIVE ANALYSIS

28. GENERIC PROVISIONS NORMAL RISK NO SIGNIFICANT RISK 0,0%0,00% 0,6%0,15%  LOW RISK MEDIUM - LOW RISK MEDIUM RISK MEDIUM - HIGH RISK HIGH RISK  1,5%0,60% 1,8%0,,90% 2,0%1,50% 2,5%2,25%

29. GENERIC PROVISIONS GENERIC PROVISIONS  “OLD STATISTICAL  “OLD GENERIC” VOLUME VARIATION  VOLUME   “OLD GENERIC”  “OLD STATISTICAL SPECIFIC LOAN LOSS PROVSIONING GENERIC LOAN LOSS PROVISIONING EVERY YEAR, FOR EACH KIND OF RISK

30. THE SPANISH EXPERIENCE The Spanish experience shows that priorities have to be set to strike a balance and address the challenges that arise around the credit risk control and management modernisation processes, where international convergence trends from different perspectives still need mutual understanding and further coordination.