Download as PDFNotes to the accounts
For the year ended 31st December 2007
47 Credit risk (continued)
Settlement risk
The Group is exposed to settlement risk in its dealings with market counterparties (predominantly other financial institutions). These risks arise, for example, in foreign exchange transactions when Barclays pays away its side of the transaction to another bank or other counterparty before receiving payment from the other side. The risk is that the counterparty may not meet its obligation. It also arises on derivative contracts where the carrying value of the financial asset is related to the credit condition of the counterparty.
Settlement risk also arises through the operation of a number of systems through which Barclays makes and receives payments on behalf of its customers.
While these exposures are of short duration, they can be large. In recent years, settlement risk has been reduced by several industry initiatives that have enabled simultaneous and final settlement of transactions to be made (such as payment-versus-payment through Continuous Linked Settlement and delivery-versus-payment in central bank money).
Barclays has worked with its peers in the development of these arrangements. Increasingly the majority of high value transactions are settled by such mechanisms. Where these mechanisms are not available, the risk is further reduced by dealing predominantly with highly-rated counterparties, holding collateral and limiting the size of the exposures according to the rating of the counterparty, with smaller exposures to those of higher risk.
Country risk
Credit risk is manifested as country risk where difficulties may arise in the country in which the exposure is domiciled, thus impeding or reducing the value of the asset, or where the counterparty is the country itself.
Barclays manages country risk by setting a country risk appetite, which is known as the Country Guideline and agreed at the Group Credit Committee. All cross-border or domestic foreign currency transactions are aggregated to give the current utilisation, in terms of country loss given default (CLGD), against country appetite. The level of CLGD incurred by a counterparty transaction will largely depend on three main factors: the country severity, the product severity and counterparty grade. The calculation and loss given default is described under ‘Credit Risk measurement’ below.
CLGD is incurred in the country of direct risk, defined as where the majority of operating assets are held. This may differ from the country of incorporation. However, where transactions are secured with collateral, the country risk can be transferred from the country of the borrower to the country of the collateral provider. This is only permitted where the collateral definitely covers the borrowing and is not expected to decrease over time.
Credit risk measurement
Barclays uses statistical modelling techniques throughout its business in its credit rating systems. These systems assist the Bank in frontline credit decisions on new commitments and in managing the portfolio of existing exposures. They enable a coherent approach to risk measurement across all credit exposures, retail and wholesale. The key building blocks in the measurement system are the probability of customer default (PD), exposure in the event of default (EAD), and severity of loss-given-default (LGD). Using these, Barclays builds the analyses that lead to its decision support systems in the Risk Appetite context described previously.
Where financial models are used to monitor credit risk, they are based upon customers’ personal and financial performance information over recent periods as a predictor for future performance. The models are reviewed regularly to monitor their robustness relative to actual performance and amended as necessary to optimise their effectiveness.
For corporate and wholesale customers, Barclays also assesses the credit quality of borrowers and other counterparties and assigns them an internal risk rating. There are two different categories of default rating used. The first reflects the statistical probability of a customer in a rating class defaulting within the next 12-month period, and is referred to as a point in time rating (PIT). The second also reflects the statistical probability of a customer in a rating class defaulting, but the period of assessment is 12 months of average credit conditions for the customer type. This type of rating therefore provides a measure of risk that is independent of the current credit conditions for a particular customer type, is much more stable over time than a PIT rating and is referred to as a through the cycle (TTC) rating.
Country risk grades are assigned to all countries where the Group has, or is likely to have, exposure and are reviewed every quarter to ensure they remain appropriate. Country grades, which are derived from long-term sovereign foreign currency ratings, range from 1 (lowest probability of default) to 21 (highest probability of default). A ceiling is applied where a country is graded 12 or lower so that the counterparty cannot be graded higher than the country, unless some form of protection is available in the event of a cross-border event, such as a significant portion of a counterparty’s assets or income being held or generated in a convertible currency.
As noted above, for listed debt securities, the Group has regard to both external credit ratings and internal default grades where such ratings are not available or current.
Multiple rating methodologies may be used to inform the rating decision on individual large credits, such as internal and external models, rating agency grades and, for wholesale assets, market information such as credit spreads. For smaller credits, a single source may suffice, such as the result from a rating model.
For debt securities and counterparties where third party ratings are used to inform credit decisions, the Group mainly uses those provided by Standards and Poors’ or Moody’s.
Barclays wholesale credit rating contains 21 grades, representing the Group’s best estimate of credit risk for a counterparty based on current economic conditions.
Retail customers are not assigned internal risk ratings in this way for account management purposes, although a mapping of the PIT probability of default to one of eight Barclays Retail Grades (BRG) is used for some internal reporting purposes.
The tables below detail how external rating grades, Default Grades and Barclays Retail Grades relate to the categories of credit quality selected for the financial statements. Where applicable, the internal measure of probability of default has been presented for indicative purposes.
47 Credit risk (continued)
Listed and unlisted debt securities and market counterparties where external ratings are available
Download table as excel file| External ratings | Financial statements description | ||||||||||||||
| AAA, AA+, AA, AA-, A+, A, A-,BBB+, BBB, BBB- | Strong | ||||||||||||||
| BB+, BB, BB-, B+, B | Satisfactory | ||||||||||||||
| B-, CCC+, CCC and lower | Weak / Substandard | ||||||||||||||
Wholesale lending
Download table as excel file| Default Grade | Financial statements description | Probability of default | ||||||||||||
| 1-3 | Strong | 0.0-0.05% | ||||||||||||
| 4-5 | 0.05-0.15% | |||||||||||||
| 6-8 | 0.15-0.30% | |||||||||||||
| 9-11 | 0.30-0.60% | |||||||||||||
| 12-14 | Satisfactory | 0.60-2.15% | ||||||||||||
| 15-19 | 2.15-11.35% | |||||||||||||
| 20-21 | Weak / Substandard | 11.35% + | ||||||||||||
Retail lending
Download table as excel file| Barclays Retail Grade | Financial statements description | Probability of default | ||||||||||||
| 1 | Strong | 0.0-0.15% | ||||||||||||
| 2 | 0.15-0.30% | |||||||||||||
| 3 | 0.30-0.60% | |||||||||||||
| 4-5 | Satisfactory | 0.60-2.50% | ||||||||||||
| 5-7 | 2.50-10.00% | |||||||||||||
| 8 | Weak / Substandard | 10.00% + | ||||||||||||
Financial statement descriptions can be summarised as follows:
Strong – there is a very high likelihood of the asset being recovered in full. If it is a debt security, then it will be investment grade.
Satisfactory – whilst there is a high likelihood that the asset will be recovered and therefore, of no cause for concern to the Group, the asset may not be collateralised, or may relate to retail facilities, such as credit card balances and unsecured loans, which have been conservatively classified as satisfactory, regardless of the fact that the output of internal grading models may have indicated a higher classification. At the lower end of this grade there are customers that are being more carefully monitored, for example corporate customers which are indicating some evidence of some deterioration, mortgages with a high loan to value ratio, and unsecured retail loans operating outside normal product guidelines.
Weak/Sub-standard – there is concern over the obligor’s ability to make payments when due. However, these have not yet converted to actual delinquency. There may also be doubts over the value of collateral or security provided. However, the borrower or counterparty is continuing to make payments when due and is expected to settle all outstanding amounts of principal and interest.
Credit risk mitigation, collateral, security, and other credit enhancements
The Group uses a wide variety of techniques to reduce credit risk on its lending. The most important of these is performing an assessment of the ability of a borrower to service the proposed level of borrowing. Barclays policy is to establish that loans are within the customer’s capacity to repay, rather than to rely excessively on security. As a result no security is required for a wide range of lending products.
Credit risk mitigation
Barclays actively manages its credit exposures. When weaknesses in exposures are detected – either in individual exposures or in groups of exposures – the Group takes action to mitigate the risks. Such actions may, for example, include; reducing the amounts outstanding (in discussion with the customers, clients or counterparties if appropriate); using credit derivatives securitising the assets; and, on occasion, selling them.
Barclays maintains the diversification of its portfolio to avoid unwanted credit risk concentrations. Maximum exposure guidelines are in place relating to the exposures to any individual counterparty. These permit higher exposures to higher-rated borrowers than to lower-rated borrowers. They also distinguish between types of counterparty, for example, between sovereign governments, banks and corporations. Excesses are considered individually at the time of credit sanctioning, are reviewed regularly, and are reported to the Risk Oversight Committee and the Board Risk Committee.
Similarly, country risk policy specifies risk appetite by country and avoids excessive concentrations of credits in individual countries, whilst other policies limit lending to certain industries.
A further protection against undesirable concentration of risk is the mandate and scale framework. Mandate and scale limits, which can also be set at Group level to reflect overall risk appetite, can relate either to the stock of current exposures in the relevant portfolio or to the flow of new exposures into that portfolio. Typical limits include the proportion of lending with maturity in excess of seven years and the proportion of new mortgage business that is buy-to-let.
Notes to the accounts
For the year ended 31st December 2007
47 Credit risk (continued)
Businesses may put in place other forms of credit risk mitigation, such as credit derivatives or other forms of credit protection in accordance with their procedures or policies. Hedges and mitigants are monitored and risk appetite reviewed to ensure that credit risk is kept to acceptable levels.
Collateral and security
Collateral and security can be an important mitigant of credit risk.
The Group routinely obtains collateral and security, such as in the case of a residential or commercial mortgage, a reverse repurchase agreement, or a commercial loan with a floating charge over book debts and inventories.
The Group ensures that any collateral held is sufficiently liquid, legally effective, enforceable and regularly reassessed. Before attaching value to collateral, businesses holding specific, agreed classes of collateral must ensure that they are holding a correctly perfected charge.
The principal collateral and security types are as follows:
- – Personal lending – mortgages over residential properties;
- – Commercial and industrial sector – charges over business assets such as premises, stock and debtors, and third party credit protection (i.e. guarantees);
- – Commercial real estate sector – charges over the properties being financed; and,
- – Over-The-Counter (OTC ) trading exposures – cash; direct debt obligation government (G14+) bonds denominated in the domestic currency of the issuing country, debt issued by supranationals and letters of credit issued by an institution with a long-term unsecured debt rating of A+/A3 or better.
Valuation of the collateral and security taken is within agreed parameters.
Before reliance is placed on third party protection in the form of bank, government or corporate guarantees or credit derivative protection from financial intermediary counterparties, a credit assessment is undertaken. Eligibility parameters for guarantees and credit derivative are similar to those applied to collateral held against OTC traded exposures.
Any collateral taken in respect of OTC trading exposures will be subject to a ‘haircut’ which is negotiated at the time of signing the collateral agreement. A haircut is the valuation percentage applicable to each type of collateral and will be largely based on liquidity and price volatility of the underlying security.
The Group also uses various forms of specialised legal agreements to reduce risk, including entering into master netting agreement with counterparties, which the Group uses to restrict its exposure to credit losses. Group policy requires all netting arrangements to be legally documented. The ISDA Master Agreement is the Group’s preferred agreement for documenting OTC activity. It provides the contractual framework within which dealing activities across a full range of OTC products are conducted and contractually binds both parties to apply close-out netting across all outstanding transactions covered by an agreement if either party defaults or other pre-determined events occur. In the normal course of events, where the master agreement is ISDA, the collateral document will be the ISDA Credit Support Annex (CSA). The collateral document must give Barclays the power to realise any collateral placed with it in the event of the failure of the counterparty, and to place further collateral when requested or in the event of insolvency, administration or similar processes, as well as in the case of early termination.
Security structures and legal covenants are subject to regular review, at least annually, to ensure that they remain fit for purpose and remain consistent with accepted local market practice.
Any properties repossessed are made available for sale in an orderly and timely fashion, with any proceeds realised being used to reduce or repay the outstanding loan. For business customers, in some circumstances,where excess funds are available after repayment in full of the outstanding loan, they are offered to any other, lower ranked, secured lenders. Any additional funds are returned to the customer. Barclays does not, as a rule, occupy repossessed properties for its business use.
Maximum exposure to credit risk before collateral held or other credit enhancements
For financial assets recognised on the balance sheet, the exposure to credit risk equals their carrying amount. For financial guarantees granted, the maximum exposure to credit risk is the maximum amount that Barclays would have to pay if the guarantees were to be called upon. For loan commitments and other credit related commitments that are irrevocable over the life of the respective facilities, the maximum exposure to credit risk is the full amount of the committed facilities.
The following table presents the maximum exposure at 31 December 2007 and 2006 to credit risk of balance sheet and off balance sheet financial instruments, before taking account of any collateral held or other credit enhancements and after allowance for impairment and netting where appropriate.
47 Credit risk (continued)
This analysis and all subsequent analyses of credit risk include financial assets subject to credit risk only. They exclude other financial assets, mainly equity securities held in trading portfolio or available for sale as well as non-financial assets. The nominal value of off-balance sheet credit related instruments are also shown, where appropriate.
Financial assets designated at fair value held in respect of linked liabilities to customers under investment contracts have not been included as the Group is not exposed to credit risk on these assets. Credit losses in these portfolios, if any, would lead to a reduction in the linked liabilities and result in no direct loss to the Group.
Download table as excel file| 2007 | 2006 | ||||||||||||||
| £m | £m | ||||||||||||||
| On balance sheet: | |||||||||||||||
| Cash and balances at central banks | 5,801 | 7,345 | |||||||||||||
| Items in course of collection from other banks | 1,836 | 2,408 | |||||||||||||
| Trading portfolio: | |||||||||||||||
| Treasury and other eligible bills | 2,094 | 2,960 | |||||||||||||
| Debt securities | 152,778 | 140,576 | |||||||||||||
| Traded loans | 1,780 | 1,843 | |||||||||||||
| Total trading portfolio | 156,652 | 145,379 | |||||||||||||
| Financial assets designated at fair value held on own account: | |||||||||||||||
| Loans and advances | 23,491 | 13,196 | |||||||||||||
| Debt securities | 24,217 | 12,100 | |||||||||||||
| Other financial assets | 3,545 | 2,792 | |||||||||||||
| Total financial assets designated at fair value held on own account | 51,253 | 28,088 | |||||||||||||
| Derivative financial instruments | 248,088 | 138,353 | |||||||||||||
| Loans and advances to banks | 40,120 | 30,926 | |||||||||||||
| Loans and advances to customers: | |||||||||||||||
| Residential mortgage loans | 111,955 | 94,511 | |||||||||||||
| Credit card receivables | 14,289 | 13,399 | |||||||||||||
| Other personal lending | 24,968 | 20,511 | |||||||||||||
| Wholesale and corporate loans and advances | 183,109 | 143,836 | |||||||||||||
| Finance lease receivables | 11,077 | 10,043 | |||||||||||||
| Total loans and advances to customers | 345,398 | 282,300 | |||||||||||||
| Available for sale financial investments: | |||||||||||||||
| Treasury and other eligible bills | 2,723 | 2,420 | |||||||||||||
| Debt securities | 38,673 | 47,912 | |||||||||||||
| Total available for sale financial investments | 41,396 | 50,332 | |||||||||||||
| Reverse repurchase agreements | 183,075 | 174,090 | |||||||||||||
| Other assets | 3,966 | 4,097 | |||||||||||||
| Total on balance sheet | 1,077,585 | 863,318 | |||||||||||||
| Off balance sheet: | |||||||||||||||
| Acceptances and endorsements | 365 | 287 | |||||||||||||
| Guarantees and letters of credit pledged as collateral security | 35,692 | 31,252 | |||||||||||||
| Commitments | 192,639 | 205,504 | |||||||||||||
| Total off balance sheet | 228,696 | 237,043 | |||||||||||||
| Total maximum exposure at 31st December | 1,306,281 | 1,100,361 | |||||||||||||
Notes to the accounts
For the year ended 31st December 2007
47 Credit risk (continued)
Whilst the Group’s maximum exposure to credit risk is the carrying value of the assets, or, in the case of off-balance sheet items the amount guaranteed, committed, accepted or endorsed, in most cases the likely exposure is far less due to collateral, credit enhancements and other actions taken to mitigate the Group’s exposure, described below for each class of financial instrument:
| Asset | Nature of collateral obtained or other credit risk mitigation |
| Cash with central banks, items | Due to the nature of the counterparties, collateral is generally not sought on these balances which are |
| in the course of collection, and | considered to be low risk. |
| loans and advances to banks | |
| Trading portfolio | The credit risk of these assets is reflected in their fair values. No collateral or enhancements are obtained |
| directly from the issuer or counterparty but may be implicit in the terms of the instrument. | |
| Financial assets designated at fair value | The credit risk of these assets is reflected in their fair values. Debt securities may be collateralised, according to |
| held on own account | their terms. Loans and advances included in this category may be collateralised. |
| Derivatives | Credit risk is also minimised where possible through netting agreements whereby derivative assets and |
| liabilities with the same counterparty can be offset. Collateral will also be sought, depending on the | |
| creditworthiness of the counterparty and/or nature of the transaction. | |
| Loans and advances to customers | |
| –Residential mortgage loans | These are secured by a fixed charge over the property. In addition, portfolios may be securitised. |
| –Credit card receivables | This lending is generally unsecured. Balances may be securitised. |
| –Other personal lending | In general this is unsecured. For certain personal lending, a charge over the borrower’s property or other |
| assets may be sought. | |
| –Wholesale and corporate loans | Various forms of collateral may be sought for these loans, often in the form of a fixed charge over the |
| and advances | borrower’s property and a floating charge over the current assets of a corporate borrower. Loan covenants |
| may be put in place to safeguard the bank’s financial position. If the exposure is sufficiently large, either | |
| individually or at the portfolio level, credit protection in the form of guarantees, credit derivatives or | |
| insurance may be taken out. | |
| –Finance lease receivables | The net investment in the lease is secured through retention of legal title to the leased assets. |
| Available for sale assets | No collateral or enhancements are obtained although collateral may be inherent in the structure of the asset. |
| Reverse repurchase agreements and | These loans are fully collateralised with the securities legally transferred to the Group. The level of collateral |
| cash collateral on securities borrowed | is monitored daily and further collateral calls made when required. |
| Off balance sheet | The Group applies the same risk management policies for off balance sheet risks as it does for its on balance |
| sheet risks. Collateral may be sought, depending on the strength of the counterparty and/or nature of | |
| the transaction. | |
| Acceptances and endorsements | Amounts paid are normally repaid by the customer on presentation. |
| Acceptances and endorsements | Amounts paid are normally repaid by the customer on presentation. |
| Guarantees and letters of credit | The Group is only required to meet its obligations should the customer default, in which case the Group will |
| pledged as security | generally have recourse to the customer. |
| Commitments | |
| These are commitments to future lending and are subject to the Group’s normal lending policies including | taking collateral depending on the customers’ circumstances. |
Financial assets that would be past due or impaired had their terms not been renegotiated
Financial assets are generally renegotiated either as part of an ongoing customer relationship or in response to an adverse change in the circumstances of the borrower. In the latter case renegotiation can result in an extension of the due date of payment or repayment plans under which the Group offers a concessionary rate of interest to genuinely distressed borrowers. This will result in the asset continuing to be overdue (delinquent) and will be individually impaired where the renegotiated payments of interest and principal will not recover the original carrying amount of the asset. In other cases, renegotiation will lead to a new agreement, which is treated as a new loan.
Credit risk concentrations
A concentration of credit risk exists when a number of counterparties are engaged in similar activities and have similar economic characteristics that would cause their ability to meet contractual obligations to be similarly affected by changes in economic or other conditions.
The analyses of credit risk concentrations presented below are based on the location of the counterparty or customer or the industry in which they are engaged, otherwise, the product type in accordance with the manner in which the Group manages credit risk.
47 Credit risk (continued)
Analyses of the Group’s credit exposure are set out below:
Credit risk concentrations by geographical sector
Download table as excel file| 2007 |