Singapore – MAS Issues Information Paper On Its Thematic Review Of Collateral Management Standards And Practices Of Corporate Lending Business.

Theme

MAS’ general expectation

Commendable practices

Areas of improvement

Governance over Collateral Management

Governance and oversight by the Board and senior management

Generally, MAS expects the Board and senior management to be responsible for setting business and risk management strategies for its lending activities, which form the basis of the bank’s credit underwriting framework and collateral management policies and procedures.

Independence of units responsible for collateral management

MAS expects banks to have proper segregation of duties,

Governance and oversight by the Board and senior management

Generally, the Board and senior management of banks have implemented appropriate frameworks. Collateral management issues are included in credit risk management agenda and discussed at credit risk committee meetings. Such issues include banks’ collateral composition, acceptance of new types of collateral and results of collateral-related stress tests.

Independence of units responsible for collateral management

Most banks have instituted proper segregation of duties in

Independence of units responsible for collateral management

Some banks have collateral management

Theme

MAS’ general expectation

Commendable practices

Areas of improvement

where functions responsible for collateral monitoring and management are independent of front office.

the reporting lines of units responsible for collateral management.

roles performed by the front office or units reporting to the business heads, which were done without endorsement or oversight by the second line of defence.

This may pose issues as the front office (being the business unit originating the loans and often having to fulfil business targets) may not be incentivised to escalate and report certain issues, such as aggressive valuers, overly optimistic valuations or overdue valuations. Where the front office is tasked with such responsibilities, the second line of defence should play a role in mitigating such conflicts of interest inherent in the front office.

To ensure objectivity, MAS expects a unit independent of the front office, to exercise oversight or conduct independent checks to ensure that such issues are escalated for management’s attention.

Collateral Portfolio Monitoring

Data governance and management

MAS expects banks to have timely, accurate and comprehensive information on credit exposures and collateral portfolios to facilitate proactive and prompt credit risk monitoring and oversight by the relevant functions, senior management and the Board. Checks and processes should also be established to ensure the integrity of credit and collateral data that form the basis for credit monitoring and decisions.

Data governance and management

Banks typically have collateral management information systems that maintain records of collateral data (eg latest collateral valuation, due dates for revaluation, security coverage and loan to value covenants). Some banks have integrated systems that allow a single point of data entry to capture different aspects of collateral information, whereas others have multiple, distinct systems to record collateral information.

Data governance and management

Using multiple systems to maintain collateral information may require multiple data entries into the various systems. This can in turn lead to heavy reliance on manual data inputs, which are more prone to errors and can affect the integrity and quality of reporting and monitoring. The bank’s ability to extract information for timely reporting may also be affected.

To reduce the extent of human intervention and associated risks, MAS notes that some banks are exploring opportunities to

Theme

MAS’ general expectation

Commendable practices

Areas of improvement

Monitoring of collateral portfolio composition

Banks are expected to establish processes to regularly monitor and report the composition of their collateral portfolios.

Monitoring of collateral portfolio composition

There are varying standards of collateral monitoring and reporting across banks. Some banks have comprehensive and regular reports that are submitted to credit committees and senior management on a monthly basis.

leverage technology by implementing system- based solutions. That said, where manual processes continue to be in place, MAS expects banks to establish checks to mitigate the risks of data errors and misreporting (e.g. reconciliation of information in various systems, robust maker- checker controls or four- eye checks).

Monitoring of collateral portfolio composition

Some banks did not prepare reports on collateral for management’s review.

As such, such banks run the risk of not being able to identify, or respond to, emerging adverse trends or increasing concentration risks on a timely basis. This may be particularly important for banks that are highly concentrated in certain collateral types. Further, some banks did not put in place any collateral concentration limits, although they monitor industry exposure limits as proxies to collateral concentration. However, this has its limitations, as borrowers do not necessarily pledge assets that are part of their business activities, and could provide their personal or other assets as collateral for corporate loans.

To mitigate the aforesaid risks, the Info Paper encourages banks to establish processes to periodically analyse and report to the Board and senior management, the composition of their collateral portfolio and any potential concerns. Banks should also set triggers to identify

Theme

MAS’ general expectation

Commendable practices

Areas of improvement

Stress testing

MAS expects banks to conduct stress tests, as necessary, that would identify vulnerabilities in their collateral portfolios to adverse external factors or market conditions for management’s attention.

emerging risks or concentrations in their portfolios.

Stress testing

Banks do not typically conduct stress tests specifically on collateral portfolios. However, they conduct regular stress tests on loan portfolios, which may encompass some aspects of stresses on collateral.

That said, there may still be limitations as a borrower’s pledged collateral may not reflect its industry. As such, banks should subject the collateral to the relevant stress test parameters as far as possible. As an example, parameters used in stress tests on exposures to property developers could be similarly applied to stress the value of a real estate collateral pledged by a borrower in the manufacturing industry, where appropriate. This is useful in providing insights to the valuation of such collateral under stress and their impact on the bank’s loan asset quality.

Overall, banks are encouraged to conduct stress tests on collateral, where applicable. Instances where such stress tests are warranted, include: where the collateral portfolio is concentrated in certain asset classes; or where certain asset classes are susceptible to emerging risks. It would be prudent for banks to stress these collateral valuations to identify vulnerabilities for management’s attention.

Valuer Selection

Independence of appraisers

MAS expects that appraisers, and providers of appraisal

Independence of appraisers

Most banks rely on external sources of valuations from

Theme

MAS’ general expectation

Commendable practices

Areas of improvement

pricing systems or sources, to be independent of the business and front office to ensure objectivity of valuations provided.

Due diligence and review of valuers

Generally, MAS expects collateral valuations to be performed by appraisers who are subject to the bank’s due diligence and regular re- assessments of their professionalism, expertise, track record and independence.

appraisers accredited by professional bodies, although some supplement these with internal valuations by in-house specialists. These in-house specialists typically report to a unit independent of front office, to ensure independence and objectivity in the valuations used.

Some banks have also established clear criteria to determine when external appraisals are required, in addition to internal assessments.

Due diligence and review of valuers

Whilst banks place heavy reliance on valuation services provided by external appraisers, they remain responsible for ensuring that such valuations are accurate, unbiased and appropriate. To this end, most banks have established structured due diligence processes for the assessment and selection of valuers, and including them on their approved panel of valuers.

Due diligence and review of valuers

A few banks have relied on “commonly-used” valuers in the industry, instead of establishing a panel of approved valuers. These “commonly-used” valuers, albeit known in the industry, were however not subject to any internal due diligence and regular reviews. Some banks had also formalised their panel of valuers without performing any due diligence or documenting the due diligence performed. When valuers not on the bank’s panel were used, proper justification and approval were also not found.

A lack of guidance on the process to reinstate valuers to the panel was also observed in one bank. Consequently, a valuer that was previously removed from the panel due to concerns over providing valuations that were overly optimistic or aggressive, was subsequently reinstated without performing adequate due diligence.

Valuation Practices

Frequency and type of valuation

MAS expects collateral to be valued at its net realisable

Frequency and type of valuation

Most banks require annual revaluation of collateral and

Frequency and type of valuation

Clear policies to guide the revaluation of collateral

Theme

MAS’ general expectation

Commendable practices

Areas of improvement

value, based on reasonable and prudent assumptions. It should be revalued on a regular basis, with the frequency dependent on factors such as the nature of the collateral, volatility of price changes and market outlook. Clear requirements on the types of acceptable valuation (ie whether full, desktop or indicative) are specified for both initial valuation and subsequent updates. Where it is not feasible or impractical to perform onsite inspections, the risks of not doing so are properly addressed.

Valuation practices for non- performing loans (“NPLs”)

Banks are expected to adopt more stringent valuation requirements for collateral of problem credits. The collateral of problem credits should be subject to more frequent revaluation, to ensure that the haircuts are reasonable and valuation reflective of the net realisable value under stressed conditions.

have clear requirements on the acceptable types of valuation for various collateral classes. Most banks also specify the acceptable validity period of valuations obtained, for instance, valuations of real estate collateral are valid only if they are performed within the last six months.

Valuation practices for NPLs

All banks require collateral to be revalued on a more frequent basis when loans become non- performing. Further, most banks also impose minimum haircuts (ie market price discounts) on collateral values to better reflect the collateral’s net realisable value during liquidation.

were not implemented by some banks, resulting in inconsistent practices. One bank allowed revaluation on a discretionary (rather than periodic) basis for performing loans. Another bank exempted some classes of collateral, namely machinery and vehicles, from the need for revaluation altogether.

Where onsite inspections are impractical, banks rely mostly on desktop valuations during their periodic credit reviews, where valuations of these collateral could be reasonably benchmarked to market prices based on asset specifications. While such practical considerations are valid, MAS expects banks to assess the reasonableness and prudence of the assumptions underpinning the desktop valuation, and maintain clear documentation of the assessment.

There were instances where there was no follow up on significant deviations in valuations obtained from more than one valuer. As banks obtain different sources of valuations as a form of sanity check, inadequate follow-up on significant variances would render such reasonableness checks ineffective.

Valuation practices for NPLs

Some banks did not prescribe the types of valuation (ie whether full, desktop or indicative) required to be obtained when a loan turned non- performing. Such guidance would be useful given that different types of valuation are based on different assumptions and

Theme

MAS’ general expectation

Commendable practices

Areas of improvement

Banks should periodically backtest and assess the reasonableness of haircuts imposed on its collateral, taking into account market conditions and loss experience. Where limitations in internal data exist for such assessments, banks source for reference data that is representative of their portfolio.

entail differing levels of due diligence and assurance.

Additionally, some banks did not set baseline haircuts but relied on the experience and judgement of staff in determining the appropriate haircuts on a case-by-case basis. Other banks did not periodically review the reasonableness of their haircuts, citing the lack of historical liquidation data.

Banks should however develop liquidation cost and haircut assumptions for collateral valuation, based on observed empirical evidence or loss experience. Reasonable effort should also be taken to source for reference data that is representative of their collateral portfolios when setting haircuts. Further, banks should periodically backtest and review the baseline haircuts to ensure that they remain appropriate.