Are uncommitted facilities or limits considered to be regulatory off-balance sheet items and do they have to be included in the conversion factor estimation under Advanced-IRBA?
For the exposure value determination under the Credit Risk Standardised Approach (SA), Article 111 (1) CRR stipulates that the “exposure value of an off-balance sheet item listed in Annex I shall be [a further specified] percentage of its nominal value after reduction of specific credit risk adjustments and amounts deducted in accordance with point (m) of Article 36(1)”.
For the exposure value determination under the Internal-Ratings Based Approach (IRB) for institutions which meet the requirements for the use of own estimates of conversion factors, Article 166 (8) CRR refers to the “committed but undrawn amount multiplied by a conversion factor”.
Article 4 (1) (56) CRR defines the term ‘conversion factor’ as “the ratio of the currently undrawn amount of a commitment that could be drawn and that would therefore be outstanding at default to the currently undrawn amount of the commitment, the extent of the commitment being determined by the advised limit, unless the unadvised limit is higher”, and, thus, the conversion factor describes the potentiality of future drawings under a currently undrawn commitment. As a consequence, for purposes of determining the conversion factor, a “commitment” is required – in the absence of a commitment, there is no undrawn amount to be multiplied by a conversion factor.
While there is no definition of the term ‘committed / commitment’ in the CRR, we understand that ‘committed’/’commitment’ means any legally binding contractual arrangement that has been offered by the bank to extend financing to the client, purchase assets or issue guarantees. Irrespective of whether it is a requirement for a “commitment” that the offer by the bank to provide financing has already been accepted by the client (as provided in paragraph 127 letter b) of the ECB Guide to internal model as well as in paragraph 78 of the Basel 4 text (BCBS 424)) or whether it may also include constellations where the client has not yet provided its agreement (see the definition provided in the EBA Policy Advice on the Basel III reforms: credit risk), the key distinguishing feature between “committed” and “uncommitted” credit limits seems to be that uncommitted credit limits are characterized, or structured such, that they do not create a legally binding obligation for the institution to provide financing to the client because the contractual arrangement entered into by the institution and the client does not provide for such obligation (e.g. because the agreement leaves it to the institution’s full discretion whether it provides financing or not).
The definition of uncommitted, based on the description provided by BCBS 424, is also strictly related to the fact that the Bank receives no fees or commissions to establish or maintain the arrangements with the client despite holding full authorization over the final decision on the execution of each drawdown based on an accurate creditworthiness assessment of the client prior to drawdown.
In the following, we describe the nature of uncommitted advised (i.e. communicated to the client) as well as uncommitted unadvised (i.e. not communicated to the client) limits and why they do not allow the client to receive financing (e.g. by drawing on a facility) and, thus, should not be considered to constitute a regulatory off-balance sheet item.
Uncommitted and advised credit limits: In order to provide the client with an indication about its potential funding capabilities, the institution may advise a (uncommitted) credit facility to the client. The communication to the client clarifies, however, that the advised credit facility does not constitute a legally binding agreement or offer to, in fact, provide financing to the client. As a matter of fact, the client is invited to submit utilization requests under the facility, however the client has no contractual right to receive funding under this facility. Correspondingly, the institution can refuse utilisation requests by the client at any time, at its sole discretion, without providing reasoning or providing a notice of termination of the uncommitted credit line. The purpose of such uncommitted and advised credit facilities is to have a “framework” agreement to set out the terms and conditions that can be applicable to an utilization in the future in order to facilitate/simplify the process, so that as and when the institution were to accept an utilization request by the client, there is no need to start negotiating the terms or to get the client to sign an agreement for that utilization under the credit facility. Uncommitted and advised credit limits effectively serve operational efficiency purposes, but do not create any obligation by the institution towards the client.
Another example of uncommitted and advised credit limits is a constellation where the contractually arrangements does not explicitly permit overdrafts, but rather provides for the terms and conditions in case the Bank would, without being obliged to do so, in fact, allow and tolerate overdrafts.
Uncommitted and unadvised credit limits: Uncommitted and unadvised credit limits are not externally communicated to the client; they serve internal purposes only. They are communicated only bank-internally (e.g. to Front Office in order to facilitate the credit granting process in case of an individual client request as a placeholder limit) – in such case, any granting of credit would always be subject to a separate contractual arrangement entered into between the bank and the client. Consequently, uncommitted and unadvised credit limits do not create any obligation or liability by the institution towards the client either.
In view of this, uncommitted limits (irrespective of whether advised or unadvised) should not constitute regulatory off-balance sheet items since it remains at the institution’s sole discretion whether it provides financing, e.g. in the form of a loan, or not. Accordingly, uncommitted credit lines are not to be regarded for the internal conversion factor estimation under the Advanced-IRBA. This view applies to retail as well as non-retail obligors.