Chapter I Objectives of the Risk-Based Loan Classification SystemI. These Guidelines are formulated to facilitate the development of a modern and well-developed banking system, improve the methodology of loan classification, strengthen credit management and enhance credit quality.II. The loan classification system as described in these Guidelines refers to a process of categorizing loans of commercial banks according to their risk. The system is expected to achieve the following objectives:1. To assess the real value and risk of loans and reflect credit quality in a reliable, comprehensive and dynamic manner.2. To identify weaknesses in origination, management, monitoring, workout of loans as well as other problems relating to non-performing loans (NPLs) in the interest of enhanced credit management.3. To provide the basis for assessing adequacy of loan loss provision.Chapter II Criteria for the Risk-Based Loan ClassificationIII. The loan classification system described here follows a risk-based approach, whereby loans are divided into five categories - pass, special-mention, substandard, doubtful and loss - with the last three categories recognized as NPLs.IV. Definitions of the five categories Pass: borrowers can honor the terms of the contracts, and there is no reason to doubt their ability to repay principal and interest of loans in full and on a timely basis. Special-mention: borrowers are still able to service the loans currently, although the repayment of loans might be adversely affected by some factors. Substandard: borrowers' ability to service loans is apparently in question, cannot depend on their normal business revenues to pay back the principal and interest of loans and certain losses might incur even when guarantees are executed. Doubtful: borrowers cannot pay back principal and interest of loans in full and significant losses will incur even when guarantees are executed. Loss: principal and interest of loans cannot be recovered or only a small portion can be recovered after taking all possible measures and resorting to necessary legal procedures.V. In essence, the risk-based loan classification system is to evaluate the possibility of borrowers to pay back principal and interest of loan in full and on a timely basis. The main factors in classifying loans are as follows:1. Repayment ability of borrowers;2. Credit records of borrowers;3. Willingness of borrowers to repay;4. Guarantee of loans;5. Legal obligations of loan repayment; and6. Credit management of banks.The repayment ability of borrowers is defined broadly to cover borrowers' cash flow, financial conditions as well as relevant non-financial factors.VI. The classification of loans should be based on the assessment of repayment ability of borrowers and consider the normal business revenues of borrowers as the primary source of repayment, while treating loan guarantees as a secondary source of repayment.VII. Loans under restructuring should be classified at least as substandard, and restructured loans should be classified as doubtful if they remain overdue or borrowers are still unable to repay.Restructured loans refer to loans whose contractual terms of repayment have been renegotiated owing to deterioration of financial conditions of borrowers or their inability to repay. Restructured loans may be classified less favorably in accordance with Article IV and V of the Guidelines if other serious deficiencies are identified.VIII. The deliberate evasion of debt obligations by borrowers by way of merger, acquisition, or split-up should be classified at least as special-mention, and should be reclassified in light of borrowers' real repayment ability after taking legal procedures.IX. The status of overdue is one important indicator for loan classification. Loans that are overdue beyond certain time span (including rescheduling) and whose interest receivable is no longer recognized as income in the income statement should be classified as substandard or of a lower category.X. Loans extended in violation of laws and regulations should be classified as special-mention or of a lower category.Chapter III Basic Requirements for Loan ClassificationXI. Loan classification is an essential element of commercial banks' credit management. In the process of loan classification, commercial banks should meet at least the following six requirements.1. Sound internal control system and sound credit policies and procedures; 2. Effective organizational structure for credit management; 3. Separation of loan approval from loan release; 4. Sound documentation system to ensure the integrity of loan documents; 5. Sound information management system to ensure that the management of commercial banks receives all important credit information on a timely basis; and 6. Mechanisms to ensure that borrowers provide reliable and accurate financial information.XII. The risk-based loan classification system as described in the Guidelines is the minimum requirement for loan classification, and forms the very basis for assessing banks' credit quality.Commercial banks can either adopt the loan classification criteria in Chapter II or develop their own classification system with reference to the Guidelines and in light of their own credit risk management policies.The commercial banks' own loan classification system should be compatible to and convertible to the PBC's classification system and should be submitted to the PBC for record.XIII. Borrowers' rating may not be used to substitute loan classification although it can serve as a useful indicator for classifying credit.XIV. If factors affecting borrowers' financial conditions or loan repayment ability change significantly, loans in question should be reclassified accordingly on a timely basis.Commercial banks should classify all their loans at least semi-annually. More frequent review and classification are needed for NPLs, and appropriate measures should be taken accordingly to address the risk of loans. XV. Commercial banks should strengthen maturity management on credits while adopting the risk-based loan classification. Overdue loans should be measured and monitored according to the PBC's rules and regulations.XVI. Commercial banks should formulate explicit policies and procedures governing the evaluation and management of collateral and lien. Collateral should be evaluated accordingly based on their market prices where available or with reference to market prices of similar collateral where market prices are not readily available.XVII. Commercial banks should formulate explicit policies on loan guarantees. Classification on loans under guarantees should consider the effectiveness of the guarantee contracts and the ability of guarantors to honor their obligations.XVIII. Credit officers of commercial banks should have sufficient knowledge in credit analysis and have a clear understanding of the essential elements of the risk-based loan classification system. Training and necessary actions in other areas are essential to ensure the effectiveness of the loan classification system.Chapter IV Implementation of the Risk-based Loan Classification SystemXIX. Commercial banks shall have effective internal controls to ensure the independence, continuity and integrity of the loan classification exercise.XX. The internal reporting system of commercial banks should specify the clear reporting procedures on loan classification to ensure that the management is fully aware of the loan quality and the changes of loan quality over time.XXI. Credit officers should have a good understanding of borrowers and their loans, and are responsible for reporting the true information about borrowers and their loans to the loan review department in writing.XXII Internal auditing departments of commercial banks should regularly review and evaluate policies and implementation of loan classification and report their findings in writing to the management or the board of directors.Chapter V Monitoring and Oversight of the Risk-Based Loan Classification SystemXXIII The PBC should review the loan quality of commercial banks by way of on-site monitoring and off-site examinations.XXIV The PBC should in principle conduct on-site examinations on loan quality of commercial banks annually, including specifically-targeted and regular examinations. More stringent oversight is required for commercial banks with significant loan quality problems.XXV The PBC, when reviewing loan quality of commercial banks, shall not only classify loans independently, but also assess the credit policy, credit risk management and the methodology, procedures as well as effectiveness of loan classification of commercial banks.XXVI Commercial banks should report the loan classification statistics to the PBC in line with its reporting requirements.XXVII Loan losses and the write-off of loan losses of commercial banks should be disclosed in line with relevant rules and regulations.Chapter Six Auxiliary Provisions XXVIII Loans refer to all types of loans specified in General Rules on Lending.XXVIV Other assets including such off-balance sheet items as direct credit substitutes, should also be categorized as pass, special-mention, substandard, doubtful and loss according to their net values of assets, repayment ability, credit standings and guarantees involved, with the latter three classified as non-performing assets.The classification exercise should be focused on the integrity of asset value, with specific reference to the criteria and requirements of the risk-based loan classification.XXX Commercial banks should make adequate loan loss provisions and write off loan losses in line with sound accounting principles, relevant rules and regulations issued by the Ministry of Finance as well as the guidelines on loan loss provisions issued by the PBC.XXXI The Guidelines should be applied to all commercial banks.Policy banks and other financial institutions engaged in credit operations may establish their own loan classification systems in line with the Guidelines, and should be at least as stringent as the criteria and requirements of the Guidelines.XXXII The PBC is responsible for the interpretation of the Guidelines.XXXIII The Guidelines shall take effect at its announcement. 16
Date of last update
Nov. 29 2018
