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 periodic counterparty review and assignment of risk ratings?

   3. Prescribe the method of calculating counterparty credit risk exposure?

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

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

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

   7. Describe the mechanism for policy and limit exception approvals and reporting?

   8. Outline what to do when a limit on a counterparty credit line is exceeded because of a large market move (e.g., collateral calls, up-front payments, termination)?

   9. Require annual board approval?

2. Does 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 the credit risk control function participates in the new-product approval process?

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

   1. Counterparty limits and the exceeding of such limits are monitored and approved independently of the trading floor?

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

   3. Traders are prohibited, except under specified conditions, from conducting transactions with counterparties for whom no limits have been established?

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

   5. Net 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 and early termination clauses 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?

5. Does the scope of the audit or loan review include sampling credit files to ensure compliance with policies and procedures regarding documentation?

6. Does the credit operations department or another 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?

Previous: Liquidity Risk Next: Transaction Risk