Policy Rule on the Treatment of Concentration Risk in Emerging Countries

Policy rule
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The policy rule addresses the second pillar concentration risk in more detail. Banks that have significant exposure concentrations in countries with a non-negligible risk of repayment and transformation problems as well as heightened collective default risk should adequately control these risks. The policy rule states which risk controls DNB recommends that financial institutions implement and, if they prove to be inadequate, which capital surcharges they must take into account. The institutions report this in the ICAAP, which we will assess by means of the SREP.

Published: 24 February 2014

We apply the policy rule to concentrations (>5 % of the balance sheet total and total off-balance-sheet items) in countries with a high probability of a country risk event as defined in the policy rule. We also use a table containing weighting factors and absolute limits to counter incentives to diversify to worse risks. If, at any point in the past three years, an institution's country exposure has exceeded the 5% threshold, the policy must be applied.

Estimating country risk

A financial institution is initially responsible for assessing the country risk itself. The first indicator that can be used is the sovereign foreign currency rating (long term). Other factors can also be considered in the estimate, e.g. views expressed by the IMF and OECD and an assessment of the sustainability of the country's economic growth and its balance of payments, and the stability of its financial sector. In certain cases we will also prepare a risk assessment for the countries we deem relevant in view of the characteristics of the institution concerned and inform the institution accordingly.

Risk controls

The policy rule assumes a country risk event for the largest exposure concentration in the portfolio, with regional contagion being reflected in a three-notch downgrade. Risk controls are taken into account in a weighting we have set. In particular, we are of the view that collateral, credit risk insurance, trade finance and short-maturity assets reduce a financial institution’s risk profile. If we consider the controls inadequate to mitigate the risks involved, additional capital must be held.

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