Risk management in main risk types

Credit risk

Considerable resources, expertise and controls are in place to ensure efficient and effective management of credit risk.

In lending transactions, credit risk arises through non-performance by a counterparty for facilities used. These facilities are typically loans and advances, including the advancement of securities and contracts to support customer obligations such as letters of credit and guarantees. In trading activities, credit losses arise due to non-performance by a counterparty for payments linked to trading-related financial obligations.

There are three components to credit risk:

• settlement risk – arises in transactions involving the non-simultaneous exchange of values when the group honours its obligations to deliver value and the counterparty does not;
  
• pre-settlement risk – arises where a counterparty is unable or unwilling to honour its future obligation. The group is then exposed to replacement cost risk when it subsequently arranges a transaction with a second counterparty to replace the defaulted deal; and
  
• issuer risk – arises where the issuer of a debt instrument defaults on a particular principal payment or set of payments due under the instrument or where an equity instrument collapses in price.

Market risk and credit risk overlap in traded credit products (whether traded as principal or held as collateral) including debt instruments and credit derivatives. In these circumstances, issuer concentration and default risks are managed through credit and country risk processes, and market price sensitivity through market risk processes.

Approach to managing credit risk

Credit risk is managed by means of a governance structure with clearly defined mandates and delegated authorities. The group credit committee delegates authority to the African and Standard Bank London Plc credit committees for the approval of credit proposals. These committees further delegate authority within their limits. The delegated authorities are documented and take into consideration credit quality, size of facility, and committee representation.

The primary responsibility for credit risk lies with the director, group credit. He is responsible for coordinating the management of credit risk and ensuring the level of risk is maintained within the approved credit risk profile across the group.

Credit risk heads have been appointed for both Personal & Business Banking credit (including SMEs) and Corporate & Investment Banking credit.

In the year under review the credit risk committee structure was as follows:

Credit risk committee structure

Credit risk management in the business units

Corporate & Investment Banking

Credit exposure to sovereign states, corporates and financial institutions is usually in the form of short- and long-term loans and advances, advancement of securities and contracts to support customer obligations, such as letters of credit and guarantees, and exposures created through derivative contracts. In these instances, credit risk management is characterised by a close working relationship between the counterparty, the customer relationship team and an independent credit officer. Credit decisions are based on an in-depth knowledge of the counterparty and the industry in which it operates, as well as an assessment of the creditworthiness of the counterparty based on a review of audited financial information and underlying risk parameters.

The use of sophisticated credit rating modelling techniques, combined with an in-depth knowledge and understanding of each customer, is essential in assessing the credit risk of each counterparty dealt with. To this end, a common credit rating framework has been developed to house credit rating models for each counterparty type. The probabilities of default produced by these models are an important component of the formal credit assessment process for new and existing business. In addition, these models form the basis for continual monitoring of changes in credit quality. The validation and ongoing enhancement of these models remains a focus area. Initiatives to advance credit management practices include the enhancement of default management and collateral management systems. Together these initiatives will allow the group to understand and manage the risk of the credit portfolio more dynamically, and to meet the requirements of Basel II.

Personal & Business Banking

Credit exposures include lending to individuals in the form of mortgage loans, credit card facilities, personal loans, overdrafts and asset finance facilities, as well as lending to small and medium-sized businesses.

The underlying method for credit extension is determined by the nature of the product and the strength of historical data available. In the case of individuals, and selected small and medium-sized businesses, application and behavioural scoring techniques are widely applied throughout the credit life cycle. In all other cases conventional and intuitive methods are applied to loans with decisions taken in a centralised environment strategically placed within provinces, countries and regions.

A diverse range of performance analysis techniques are applied across product sets in recognition of differing asset and maturity profiles. Defaulting accounts receive prompt attention, and in instances where loss is anticipated, are handled centrally by collection functions. Collections are a key component of the credit cycle and the underlying philosophy is to collect appropriately and promptly, using available technologies as the principal driver. The various credit portfolios are monitored regularly to evaluate the level of risk assumed against expected risk levels.

Credit exposure related to derivative financial instruments at 31 December (Rm)¹

Credit risk on trading activities

The group enters into forward, swap and option contracts, both exchange-traded and over-the-counter, on a range of underlying instruments. Counterparties to these contracts may be the consumer market, corporate companies, other financial institutions or market professionals. The contracts enable the group and its customers to manage (reduce, take-on or eliminate) their foreign exchange, interest rate, credit, commodity, precious metal and equity risks.

To the extent that a derivative contract requires performance by the counterparty at a future date, it may create credit risk for the group. This is mitigated by master-netting agreements, such as International Swaps and Derivatives Association (ISDA) agreements, between the group and its counterparties, which permit the offset of amounts due from, and due to, a counterparty in the event of default. Master-netting agreements are enforceable in the jurisdictions of most of our major counterparties. Entering into collateral arrangements with many of our counterparties provides further protection against default.

Credit risk exposure on derivatives and foreign exchange contracts is measured in terms of current exposure and potential future exposure, which are explained below.

• Current credit exposure represents the loss to the group assuming the customer defaults at the time the exposure is being measured.
  
• Potential future credit exposure represents an estimate of the potential loss to the group assuming the counterparty defaults at some future date over the remaining term of the transaction. Potential credit exposure is estimated by simulating the impact of expected changes in market rates over the life of the contract using either simple add-on factors or more complex simulation techniques.
  

Credit risk measurement

Probability of default – internal risk ratings

The group has developed rating models for all banking facilities. These models are used to assist the group in front-line credit decisions on new commitments and in managing the portfolio of existing exposures. The group assesses the credit quality and assigns an internal risk rating to all borrowers and other counterparties, including consumers.

Banking book credit exposures

Risk profile of customer exposures

Personal & Business Banking SA portfolio

The graph below shows the exposure of the scored Personal & Business Banking SA portfolios (other than for SME lending) across PD bands.

Corporate & Investment Banking portfolio

The Corporate & Investment Banking portfolio includes primary and contingent exposure to counterparties across instruments in the banking book, and is divided into three major categories, being financial institutions, corporates and sovereigns, as detailed in the graph below.

91% of the sovereign exposures in the graph above are to the South African Government.

The group is now using an internationally comparable rating scale to aggregate exposures across its Corporate & Investment Banking portfolio as detailed below.

International	Banks		Other
rating	PD bands (%)		PD bands (%)
AAA/AA/A	0 - 0,035		0,0005 - 0,0621
BBB	0,065 - 0,208		0,1235 - 0,4357
BB	0,356 - 0,961		0,7739 - 2,1850
B	2,322 - 3,466		3,4768 - 7,9144
CCC	7,128 - 13,214		15,7018 - 27,3347
CC/C	17,326 - 22,173		34,4325 - 42,1267

Where an exposure is in the local currency and is not cross-border (i.e. the Standard Bank entity and obligor have the same domicile) then an internationally comparable local rating is used. The PD associated with these ratings will be a component of the group's internal ratings-based application under Basel II.

Financial institution exposures mainly comprise placements and pre-settlement risk to domestic and international money centre banks, which the group uses to deploy its surplus liquidity and as counterparties in foreign exchange, derivatives, and commodity transactions. Sub-investment grade exposures are typically to the larger banks in emerging market countries, where the rating is capped at the country ceiling, or trade finance and capital markets business with smaller banks.

Some 70% of Corporate & Investment Banking’s corporate exposures are domestic. The balance is diversified across a broad range of industries and a large number of countries. The group makes extensive use of physical and financial collateral to mitigate corporate credit risk.

Industry analysis

The group analyses its customers per industry using SARB categories as shown in the following graph. Going forward, the industry analysis will also be done using the International Standard Industrial Classification (ISIC) codes.

The group’s largest industry exposure is to mortgage advances in Personal & Business Banking, which is included in the “individuals” category above. This exposure comprises a high number of accounts and has been a high growth area over the last five years.

In respect of the mortgage advances portfolio, the graph below shows the distribution of the loan-to-value ratios of each loan based on the value of the respective mortgaged properties as determined at the time of the last credit decision.

Many customers request the highest possible bond to be registered with a resulting high loan-to-value ratio. In addition, due to the sharp increase in property prices over the past few years, the current loan-to-value ratios will generally be considerably lower than they were at the time of registration. This impact is reflected in the graph below.

The current market values used above have been calculated using a valuation model that considers property price inflation.

Maturity analysis of the banking book for the group

An analysis of contractual maturity is set out in the graph below. Almost 60% of the loans to customers have a maturity of more than 12 months, the majority of which are mortgage advances.

Loan impairments

Non-performing loans (NPLs) and special mention loans

A high-level summary of total loans and advances is provided on the following page and has been prepared in accordance with the SARB guidelines set out below.

Standard and current	Items that are fully current and the full repayment of the contractual principal and interest amounts are expected.
Special mention	Items for which the borrower is experiencing difficulties. Ultimate loss is not expected but could occur if adverse conditions persist.
Sub-standard1	Items that show underlying well defined weaknesses that could lead to probable loss if not corrected. The risk that these items may be impaired is probable and the group relies to a large extent on the available security.
Doubtful1	Items that are considered to be impaired, but are not yet considered final losses because of some pending factors which may strengthen the quality of the items.
Loss1	Items that are considered to be uncollectable and where the realisation of collateral and institution of legal proceedings have been unsuccessful. These items are considered of such little value that they should no longer be included in the net assets of the group.
1Classified as non-performing for accounting purposes. Gross NPLs are net of interest in suspense. Loans and advances exclude any contingents and the derivative portfolios.

Standard Bank Group’s external loans and advances in line with the South African Reserve Bank regulatory definitions

	Gross
	advances				Non-performing loans						Performing loans
			Sub-								Special
	Total		standard		Doubtful		Loss		Total		mention		Standard
	Rm		Rm		Rm		Rm		Rm		Rm		Rm
2005
Domestic Banking	274 150		1 770		1 259		390		3 419		3 066		267 665
Personal & Business
Banking SA	196 393		1 423		1 222		325		2 970		3 033		190 390
Corporate & Investment
Banking SA	77 581		347		37		26		410		33		77 138
Other domestic operations	176		–		–		39		39		–		137
Rest of Africa	14 413		134		43		134		311		882		13 220
Corporate & Investment
Banking International	49 359		101		–		313		414		502		48 443
Other	67		–		–		–		–		–		67
Gross loans and advances	337 989		2 005		1 302		837		4 144		4 450		329 395
Percentage of total book (%)	100,0		0,6		0,4		0,2		1,2		1,3		97,5
Domestic Banking	100,0		0,7		0,5		0,1		1,3		1,1		97,6
Corporate & Investment Banking
International, Rest of Africa
and Other	100,0		0,3		0,1		0,7		1,1		2,2		96,7
2004
Domestic Banking	216 087		1 647		1 198		406		3 251		2 399		210 437
Personal & Business
Banking SA	153 141		1 142		1 101		321		2 564		2 380		148 197
Corporate & Investment
Banking SA	62 884		505		97		43		645		19		62 220
Other domestic operations	62		–		–		42		42		–		20
Rest of Africa	12 287		95		36		77		208		581		11 498
Corporate & Investment
Banking International	34 286		124		192		135		451		442		33 393
Other	9		–		–		–		–		–		9
Gross loans and advances	262 669		1 866		1 426		618		3 910		3 422		255 337
Percentage of total book (%)	100,0		0,7		0,6		0,2		1,5		1,3		97,2
Domestic Banking	100,0		0,7		0,6		0,2		1,5		1,1		97,4
Corporate & Investment Banking
International, Rest of Africa
and Other	100,0		0,5		0,5		0,4		1,4		2,2		96,4

Analysis of NPLs per business unit balance sheet impairment

	Gross								Net after
	NPLs (net				Securities and				securities and								Gross
	of interest in				expected				expected				Impairments for				impairment
	suspense)				recoveries				recoveries						NPLs		coverage
	2005		2004		2005		2004		2005		2004		2005		2004		2005		2004
	Rm		Rm		Rm		Rm		Rm		Rm		Rm		Rm		%		%
Personal & Business
Banking SA	2 970		2 564		1 855		1 406		1 115		1 158		1 115		1 158		38		45
Mortgage advances	1 702		1 375		1 373		913		329		462		329		462		19		34
Card debtors	161		104		47		30		114		74		114		74		71		71
Instalment sale and finance
leases	474		463		230		226		244		237		244		237		51		51
Other personal and business	633		622		205		237		428		385		428		385		68		62
Corporate & Investment
Banking SA	410		645		168		366		242		279		242		279		59		43
Corporate & Investment
Banking SA	100		314		25		188		75		126		75		126		75		40
Property finance	310		331		143		178		167		153		167		153		54		46
Other domestic operations	39		42		2		4		37		38		37		38		95		90
Domestic Banking	3 419		3 251		2 025		1 776		1 394		1 475		1 394		1 475		41		45
Rest of Africa	311		208		142		19		169		189		169		189		54		91
Corporate & Investment
Banking International	414		451		44		4		370		447		370		447		89		99
Total group	4 144		3 910		2 211		1 799		1 933		2 111		1 933		2 111		47		54
Staff home loan impairment in terms of IAS 39													90		92
Impairments for country risk													30		64
Credit risk inherent in off-balance sheet exposures and other asset classes													107		68
Total group impairments													2 160		2 335
NPL coverage % to gross advances
															2005				2004
															%				%
Gross NPLs															1,2				1,5
Less: Securities and collateral															(0,6)				(0,7)
Less: Impairments for non-performing loans															(0,6)				(0,8)
Net NPLs															0				0
Coverage: Gross1															47				54
Net2															100				100
Gross advances (Rm)															337 989				262 669
1  Gross coverage = Impairment for NPLs/Gross NPL.
2  Net coverage = Impairment for NPLs/(Gross NPL – Security).

NPL and special mention loan percentages

NPLs and special mention loans as a percentage of loans and advances have improved over the last five years primarily due to benign credit conditions and continuous improvements in credit lending and collection processes.

There are rigorous processes in place to determine the appropriate level of impairment for NPLs.

For the larger NPLs, impairments are generally determined on an individual account basis taking into account expected recoveries. Where impairments are determined on a portfolio basis, recent portfolio recovery and loss history combined with an intuitive oversight review is generally used to determine impairment adequacy.

The group impairs its performing loans and advances on an incurred loss model and is accordingly in compliance with the revised IAS 39 requirements, effective 1 January 2005.

The graph below shows total balance sheet impairments for the last ten years.

The graph below details balance sheet NPLs and the income statement total impairment charge as a percentage of total loans and advances for the last seven years.

The graph below details the movement during 2005 of total balance sheet credit impairments.