1
In effect from 28March2009
Published in the newspaper Latvijas Vēstnesis No.49 on 27March2009
As further amended by:
Regulation No.48 of the Supervisory Board of the Financial and Capital Market Commission, dated 26March2014 (Minutes No.11, Clause2)
(published in the newspaper Latvijas Vēstnesis No.63 on 28March2014)
Regulation No.35 of the Supervisory Board of the Financial and Capital Market Commission, dated 4March2015 (Minutes No.9, Clause3)
(published in the newspaper Latvijas Vēstnesis No.51 on 12March2015)
25March2009 Regulation No.42
Riga (Minutes No.11, Clause2)
Regulations on Valuation of Assets and Supervisory Provisioning
Issued in accordance with Section
55 of the Credit Institutions Law and Section
119.1, Paragraph three of the Financial Instruments Market Law
I. General Issues
1. Regulations on Valuation ofAssets and Supervisory Provisioning(hereinafter – the Regulations) shall be binding on the banks, investment firms and investment management companies registered in the Republic of Latvia, subject to the requirements governing capital adequacy (hereinafter referred to as the institution).
2. The requirements of the Regulations shall apply to all types of financial assets disclosed in the financial statements according to the amortised cost, namely, loans and financial assets held to maturity (hereinafter – the loans).
3. Terms used in the Regulations:
3.1. Credit risk - possibility of occurrence of loss in the case if the borrower is not able or refuses to fulfil the liabilities towards the institutions in accordance with the provisions of the loan agreement.
3.2. Expected loss - loss to be incurred by the institution, in the event of default of the borrower occurring. Expected loss may differ from the impairment loss recognised in the financial statements in accordance with the accounting standards, because it includes the loss that may occur due to the possible adverse effect of future events on loan repayment.
3.3. Provisions - impairment loss recognised in the financial statements in accordance with the accounting standards.
3.4. Capitalisation of interest - adding of the accumulated interest to the principal of the loan or the repayment thereof on account of a new loan issued to the borrower.
3.5. Loan restructuring - granting of concession to the borrower due to such economic or legal causes that are related to the financial difficulties of the borrower, which would not otherwise be granted by the institution and which may be expressed as:
3.5.1. any concession of the loan conditions, for example, extension of the loan maturity date postponing the loan payments, capitalisation of interest, reduction of the original interest rate;
3.5.2. taking over of the collateral or other assets for partial loan repayment;
3.5.3. replacement of the original borrower or involvement of an additional debtor.
3.6.Financial difficulties (within the meaning of Clause3.5) - such changes in the financial condition of the borrower, due to which payment delays would be allowed for and/or loan impairment loss would be recognised, if loan restructuring were not performed.
3.7. Collateral dependent loan - a loan, the repayment whereof fully depends upon the realisationof the collateral, because the borrower has no other sources for loan repayment.
3.8. Independent valuer- a person having a relevantlicence or certificate for real estate valuation and who is independent of the decision-making process on granting the loan.
3.9. Accounting standards - International Accounting Standards issued by the International Accounting Standards Board, International Financial Reporting Standards and the interpretations of the Standards of the International Financial Reporting Standards Interpretations Committee approved by the European Commission and published in the Official Journal of the European Union.
4. The use of the other terms shall correspond to the use of the terms of the accounting standards.
II. Guidelines
5. The institutions shall set up a loan review system, in order to timely reviewthe loan and determine the amount of expected loss in accordance with the bank policies and procedures, taking into account the requirements of these Regulations, and provisioning in accordance with the requirements of the accounting standards.
6. The institution shall carry out the loan review, on a regular basis, based on a comprehensive, well-documented and consistently applicable loan portfolio analysis, by means of its professional judgments, justified assumptions and taking into account all the known internal and external information affecting the loan quality (loan repayment).
7. The institution, taking into account the scope and structure of the loan portfolio, shall establish and consistently apply an internal loan classification system that allows one to credibly classify the loans in accordance with the credit risk inherent thereto, to timely and precisely identify the changes in risk characteristicsand loan issues. The internal loan classification system shall form the basis for the creditrisk management, evaluationof the expected loss and determination of the sufficientamount of provisions.
8. The institution shall develop and document the methodology for the loan review and provisioning(hereinafter – the methodology), in order to prudentlyassessthe expected loan loss and establishthe provisions to be recognised in the financial statement at the reporting date. Methodology shall be documented in the policies and procedures of the institution.
9. The institution shall develop the procedure prescribing the order, in which the institution shall consider the valuationof the real estate serving as collateral for the loan, carried out by the independent valuer. The institution shall evaluate the assumptions, restricting factors, projectionsand data used by the valuer in the valuation and, if necessary, shall adjust them.
10. In the financial statements the institution shall recognise the loan impairment loss and provisioning in accordance with the accounting standards.
11. The institution shall assess the sufficiency of provisions formed in accordance with the accounting standards for covering the expected loss. The expected loss shall exceed the amount of provisions in accordance with the accounting standards, if the quality of the loan portfolio of the institution is materially affected by the considerations not taken into account in accordance with the accounting standards. A positive difference between the amount of expected loss and the provisions in accordance with the requirements of the accounting standards shall be taken into account, when calculating own funds in accordance with Regulation (EU) No.575/2013 of the European Parliament and of the Council of 26June2013 on prudential requirements for credit institutions and investment firms and amending Regulation (EU) No.648/2012 (hereinafter referred to as EU Regulation No.575/2013) and the requirements of these Regulations.
(in the wording of the 26March2014 Financial and Capital Market Commission Regulation No.48)
12. The institution, which has receiveda permission to use the internal ratings based (hereinafter - the IRB) approach for calculating the minimum credit risk capital requirements, may use the expected loss calculated in accordance with the IRB approach as the expected loss within the meaning of these Regulations, if the institution has assessed and recognised that all the considerations significant for the reviewof the loan portfolio of the institution has been taken into account in its IRB approach.
13. The institution calculating the minimum credit risk capital requirement in accordance with the standardised approach shall assessthe expected loss, taking into account the considerations stated in Clause46 of these Regulations.
14. The management of the institution (Supervisory Board and the Management Board) shall be in charge of the setting up and effective functioning of the loan review system, which shall approve and revise, on a regular basis, the corresponding policies and procedures of the institution, as well as shall appoint the employees/structural units in charge of the implementation of these policies and procedures.
15. The management of the institution and/or the loan review committee specially set up by the institution shall, on a regular basis, reviseand evaluatethe loan review results and the sufficiencyof the provisions.
III. Loan Review and Provisioning
16. The institution, on a regular basis, however at least on a quarterly basis, and whenever the institution becomes aware of information indicative of the fact that a significant impairment of the quality of a certain loan has taken place, shall carry out loan quality verification, in order to detect whether one or several loan loss events have taken place, as mentioned in Clause21 and 22 of these Regulations.
17. The institution shall evaluatethe individually significant loans on an individual basis. The institution shall evaluateother loans either on an individual basis, or per group of loans having similar credit risk characteristics.
18. To determine which loans are individually significant the institution shall take into account the proportion of the loan with respect to the assets, loan portfolio or own funds, as well as the quality information, for example, belonging of the loan to a certain group of loans (loans to the persons related to the institution, loans with increased country risk, loans to the borrowers of a particular sector, if the situation in the sector adversely affects the financial condition of the borrowers, or the loans lack updated financial information about the borrower/surety or collateral information).
19. The institution shall individually evaluatethe loans delayed by more than 90 days (principal or interest) and the restructured loans, except in cases, where in accordance with the methodology developed by the institution the loans may be evaluatedin the groups of loans , because the loans are insignificant and the individual evaluationcosts are incommensurate as compared to the amount of possible loss.
20. The quality of the loan or the group of loans has deteriorated and the impairment loss has occurred, if there is objective evidenceof the fact that, after the original recognition of the loan, one or several loan loss events have taken place, affecting the future cash flow projectionsof the loans and this influence can be credibly evaluated.
21. The following shall be indicative of loan loss events with respect to individually evaluated loans:
21.1. material financial difficulties of the borrower/issuer;
21.2. failure to comply with the conditions of the loan agreement, i.e., delays in payments of the principal or interest of the loan;
21.3. concessions granted to the borrower due to such economic or legal causes that are related to the financial difficulties of the borrower, which would not otherwise be granted by the institution (i.e., the institution has carried out loan restructuring);
21.4. comparatively large probability that the borrower will commence the bankruptcy procedure or another type of financial reorganisation;
2.1.5. loss of active market due to financial difficulties of the issuer of the relevant financial asset;
21.6. failure to use the funds granted as the loan for the purposes specified in the loan agreement;
21.7. default on the credited project implementation conditions;
21.8. default on obligations by the person related to the borrower that affects the ability of the borrower to fulfil the loan liabilities towards the institution;
21.9. impairment of the collateral in cases where the loan repayment is directly dependent upon the value of the collateral;
21.10. other events defined as the loan loss events in the policies and procedures of the institution.
22. The loan loss exists for the group of loans, if after the original recognition of the loans, a decreasehas occurred in the future cash flows of the groupof loans, which can be credibly established, even that this decrease cannot yet be identified with the particular loans. The confirmation of the loan loss event shall include:
22.1. adverse changes in the creditworthiness of the borrowers (for example, growth in the number of delayed payments or growth in the number of credit card loans with a fully exhausted credit limit and the minimum monthly payments being paid);
22.2. economic circumstances affecting the timely fulfilment of the liabilities of the borrowers (for example, growth in unemployment rate, fall in prices of real estate serving as collateral of a mortgage loan, etc.);
22.3. other events defined as confirmation of loan loss events in the policies and procedures of the institution.
23. The institution shall register all loan loss events, irrespective of whether or not the borrower has allowed for the failure to fulfil the conditions of the agreement (delayedpayments).
Individually evaluated loans
24. If there is objective evidence of the loan impairment existing (i.e., one or several loan loss events have taken place), the institution shall calculate such impairment as the difference between the carrying amount of the loan and the value of the future cash flow, discounted by means of the original effective interest rate of the loan. For calculating the impairment loss of the loans with a fixed interest rate, the original effective interest rate, as establishedat the moment of recognition of the loan, shall be used. For calculating the impairment loss of loans with a floating interest rate, the original effective interest rate at the moment of the evaluationof the loan shall be used.
25. In the case of a short-term loan, the future cash flow shall not be discounted, if the discounting does not have a significant effect (difference between the discounted and undiscounted cash flow is immaterial).
26. The assessmentof the future cash flow shall be the best assessmentof the institution, which shall take into account all information available to the institution at the moment of preparation of the assessmentand shall be based on reasonable and justified assumptions and projectionsthat are duly documented. If, as a result of the evaluation, the institution establishesthe range of possible future cash flow (amount or timing), the future cash flow assessmentshall take into account the probability of the occurrence of scenarios.
27. Cash flow for a loan constituting a collateral-dependent loan shall be the cash flow, which may occur as a result of selling the collateral and deducting the expenses related to the selling of the collateral from it, if they are significant.
28. Cash flow for a collateral-dependent loan shall be established, taking into account:
28.1. legal proceduresof the selling of the object of collateral, duration and expenses of the selling thereof;
28.2. liquidity of the collateral;
28.3. price fluctuations and dynamics of the market prices of the collateral;
28.4. useful life of the collateral comparedwith the loan maturity
28.5. the pre-emptive rights of the institution to the revenue from the selling of the collateral;
28.6. the presence of insurance of the collateral.
29. Subject to the requirements specified in Clause9 and 28 of these Regulations, the cash flow that might occur as a result of selling the real estate is the best assessmentof the institution at the moment of the loan evaluation, based on the real estate valuationcarried out by the independent valuer, and which is reduced, if necessary, taking into account the results of the real estate value monitoring carried out by the institution.
30.If there are several loans issued to one borrower and one of the issued loans incurs a loan loss event, the institution shall evaluatethe impairment with respect to all loans issued by the institution to the relevant borrower.
31. The loan impairment loss incurred by the institution, when carrying out the restructuring of the loan, shall be evaluatedon the basis of the future cash flow of the restructured loan, taking into account the modified loan agreement conditions and using the original effective interest rate for discounting used before modifications to the loan agreement were made.
32. If the institution establishesthat there is no objective evidencepresent for the impairment of the individually evaluated loans, irrespective of whether or not these loans are significant, they shall be included in a group of loans with similar credit risk characteristicsand shall be assessed collectively in order to determine whether impairment is present with respect to such group of loans. If the institution does not have (it cannot to establish) groups of loans with similar risk characteristics, an additional evaluationshall not be performed.
Recognition of income
33. After the institution has recognised the impairment loss of the loan (group of loans), it shall henceforth in the financial statements recognise the interest income, by applying the interest rate which has been used for discounting the future cash flow, in order to establishthe amount of impairment, i.e. the original effective interest rate applied to the (net) carrying amount of the loans.
34. The institution shall only recognise the interest income in accordance with Clause33 of these Regulations, if it has reasonable confidence in complete repayment of the principal and interest of the loan and such confidence is based upon duly documented reasonable and justified assumptions and projections, and the institution shall take into account all the information available at the moment of the evaluation.
35. The institution shall ensure information in its internal accounting records about interest, which was:
35.1. accumulated on loans delayedby more than 90 days;
35.2. accumulated on restructured loans, which were delayed by more than 90 days at the moment of restructuring, and, irrespective of the duration of the delayedpayments at the moment of restructuring, on restructured loans which were restructured repeatedly during the period of one year;
35.3. capitalised, by carrying out restructuring of the loan.
36. The loan shall preserve the status of a restructured loan until the moment when confirmation is obtained that the borrower is able to make payments within the scope and term provided for in the modified loanagreement, i.e., for a period of at least one year, starting from the date when the term of the first payment has become due in accordance with the modifiedloan agreement, and the borrower has performed all the payments within the scope and term stipulated in the agreement over the period of the relevant year.
37. Information on interest mentioned in Clause35 of these Regulations shall be taken into account, when calculating own funds in accordance with the conditions of Clause11 or 65 of these Regulations.
Groups of loans
38. For the purposes of establishmentof impairment, not individually evaluated loans shall be includedin thegroups, based upon similar credit risk characteristics; for example, on the basis of the internal loan classification categories, which, in turn, shall take into account the loan type, sector, geographical location, type of collateral, delayedpayments and other relevant factors of the loan. The selected risk characteristics shall be of importance for establishmentof the future cash flow of the group of loans, because they characterise the ability of the borrower to fulfil its liabilities in accordance with the conditions of the agreement.