Page 95 - Annual Report 2022

33 Banka Kombëtare Tregtare Annual Report 2022

Banka Kombëtare Tregtare Sh.a.
Notes to the Consolidated Financial Statements for the year ended
31 December 2022 (Amounts in USD, unless otherwise stated)

5. Financial risk management (continued)
(b) Credit Risk (continued)

ii Expected credit loss measurement (continued)
1. Probability of Default
The probability of default has been modelled on the basis of the one factor Merton model. The approach to model the point-in-
time forward looking and macroeconomic PD is divided into three different steps: - The first step is to calibrate the cumulated
TTC PDs; - The second step is to include the forward look information and transform the cumulated TTC PDs to PIT PDs; - The
final step is to describe the conversion of PIT PDs to TTC PDs after a certain horizon.
Default rates are essential for the calculation of Point-in-Time Probability of Default (PD) and for the estimation of ECL.
The Bank used external default rate data for each relevant sector and region. A number of macro-economic variables sourced
from the IMF2, including historical data spanning 1990 – 2020 and baseline projections for 2021 – 2024, were considered in
modelling of PIT PD.
For non-rated accounts, PD are estimated using the nominal weighted average PD of all rated accounts within the same rating
system. However, this does not guarantee that the PD for non-rated accounts in stage 2 (NRB2) is higher than for stage 1 (NRB1).
To account for the higher risk of NRB2 exposures, the Bank mapped NRB2 to an equivalent risk grade with similar PIT PD as the
PD for NRB1 exposure for a time horizon equal to the average residual lifetime of all unexpired accounts within the same sector.
2. Loss Given Default (LGD)
Loss Given Default is defined as the percentage of the Exposure at Default (EAD) that is ultimately lost in case of default of
a counterparty, after all possible recoveries through selling of collateral or collection procedures. As regards to the loan to
customers’ portfolio, LGD is modelled using historical recovery rates or using the collateral value of the asset. The bank has
considered information about past collateral value, time in default, time to sale, sale costs, in calculating the LGD.
A defaulted collateralised asset can move through different stages post default. The bank can seize the collateral (“Possession”)
in order to sell it (“Sale”) and make up for the potential loss due to the default of the counterparty. Possession of collateral can
occur voluntarily (“handing over the keys”) or via litigation (court proceedings). And sales may be carried out by the institution
(after obtaining possession) or by means of a customer self-sale. On the date of collateral sale, any shortfall is recognised in the
P&L (write-off expense) and subsequent recoveries (debt collection either internal or external) may occur. Write-off occurs when
there is a shortfall on collateral sale. Closed and cures occur when the full outstanding is recovered with the former resulting in
the account closing (i.e. no lending). Cure refers to both closed and curing accounts. For the unsecured/uncollateralised types of
assets the value of the collateral is supposed to be 0 and the actual model is still applied taking in account pure debt collection.
In the light of this recovery process, the Bank defines LGD as the expected severity (loss) given a default.
As regards to the non-loan accounts (Treasury and Project and Structured Finance accounts), the Bank assumed the fixed Based
Estimates. The Banks mapped each collateral type in BKT portfolios to the Basel LGD segments1, each with their own LGD
estimate: Eligible financial collateral (0%), secured (25%) unsecured (45%). For the Treasury and Project and Structured Finance
portfolios, LGD values are assigned on an asset type level.
3. Exposure at Default (EAD)
An asset can have a customised, linear or bullet amortisation type. For assets with a customised amortisation type, repayment
schedules are used to estimate EAD. For assets without any amortisation type, a linear repayment plan is assumed. For off
balance sheet exposures, it is required that provisions are held against undrawn commitments. BKT’s calculation of the credit
conversion factor (CCF) values is in line with Basel II requirements under the standardised approach: “Commitments with an
original maturity up to one year and commitments with an original maturity over one year will receive a CCF of 20% and 50%,
respectively.” Early repayment/refinance assumptions are also incorporated into the calculation. However the early repayments
are considered to be 0 for all assets as the Bank’s historical data suggests insignificant material impact.