Internal Control Questionnaires and Verification Procedures

Credit Risk

1. Have the board and management established credit risk management policies and procedures for derivative activities that:

   1. Establish guidelines for derivative portfolio credit quality, concentrations, and tenors?

   2. Require at least annual counterparty review and assignment of risk ratings?

   3. Establish and define formal reporting requirements on counterparty credit exposure?

   4. Require designation of separate counterparty limits for presettlement and settlement credit risk?

   5. Require independent monitoring and reporting of aggregate credit exposure for each counterparty (including all credit exposure from other business lines) and comparison with limits?

   6. Describe the mechanism for policy and limit exception approvals and reporting, including situations where a counterparty credit line is exceeded because of a large market move (e.g., collateral calls, up-front payments, termination)?

   7. Require an evaluation of the appropriateness of customer transactions?

   8. Address transactions with undisclosed counterparties?

   9. Address permissibility and reporting of off-market trades (including historical rate rollovers)?

   10. Address administration of nonperforming contracts? (This policy should be consistent with policies adopted in traditional lending divisions.)

   11. Address allowance allocations and require derivatives credit reserves to cover expected losses?

   12. Require annual board approval?

2. Do the organizational structure and staffing of the credit risk control function:

   1. Ensure that the credit risk control function reports independently of traders and marketers?

   2. Ensure that credit risk control personnel have sufficient authority to question traders’ and marketers’ decisions (e.g., appropriateness issues)?

   3. Ensure that the credit risk control function participates in the new-product approval process?

3. Does the process for approving, allocating, and reporting a breach of credit limits ensure that:

   1. Counterparty limits and transactions that exceed limits are monitored and approved by credit officers independent of trading personnel?

   2. Traders have access to systems to ensure line availability (within presettlement, settlement, and tenor limits) before executing a transaction?

   3. Traders are prohibited from trading with customers for whom no limits have been established except under specified conditions?

   4. Written approvals are obtained for a breach of limits?

   5. Customer positions are monitored to determine the impact that changing market rates could have on the counterparty’s ability or willingness to fulfill the contract?

4. Do the bank’s procedures and written agreements regarding the use of credit enhancements address:

   1. Evaluating the counterparty’s ability to provide and meet collateral or margin requirements at inception and during the term of the agreement?

   2. Acceptable types of instruments for collateral and margining?

   3. Ability to substitute assets?

   4. Time of posting (i.e., at inception, upon change in risk rating, upon change in level of exposure)?

   5. Valuation methods (i.e., sources of pricing, timing of revaluation)?

   6. Ability to hypothecate contracts?

   7. Physical control over assets?

   8. Dispute resolution?

5. Do bank policies covering customer appropriateness:

   1. Clearly outline specific responsibilities for both credit and marketing officers?

   2. Clearly define the type of documentation, if any, to be maintained by both credit and marketing personnel?

   3. Define the types of disclosures or representations, if any, to be made to customers?

   4. Provide guidance to marketers on avoiding the implication of an advisory relationship?

   5. Provide a framework for evaluating counterparty sophistication and transaction complexity?

   6. Require an independent party periodically review counterparty exposures to identify new and significant mark-to-market exposures?

   7. Require that significant adverse exposures are brought to senior management’s attention?

6. Does the scope of the audit or loan review include:

   1. Sampling credit files to ensure compliance with policies and procedures regarding documentation and appropriateness?

   2. Sampling marketing files to ensure compliance with policies and procedures regarding documentation and appropriateness?

   3. Ensuring that sales presentations are clear, balanced, and reasonable?

   4. Reviewing marketers’ trading tapes to ensure propriety of sales discussions?

   5. Reviewing transactions with undisclosed counterparties?

7. Does the credit operations department ensure that:

   1. The bank has sufficient capacity to run all transactions through the credit exposure model at reasonable intervals?

   2. Credit exposure calculations are performed or verified by people independent of the trading function?

   3. Credit lines (including lines for presettlement, settlement, and tenor) and usage are updated and changed on the system in a timely manner?

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