Asset Quality Review

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Definition

The asset quality review (AQR) was one of the components of the comprehensive assessment performed by the ECB prior to assuming full responsibility for supervision under the single supervisory mechanism in November 2014[1].

The aim was to enhance the transparency of bank exposures by reviewing the quality of banks’ assets, including the adequacy of asset and collateral valuation and related provisions.

Asset Quality Review Thematic Areas

The review focus on bank processes and polices, in particular those related to key accounting decisions. The specific thematic areas are:

  • Classification of Financial Instruments: the classification and measurement of financial assets into Amortized Cost vs. Fair Value as per IAS 39 as well as treatment of equity positions, hedge accounting & derecognition;
  • Application of the Fair Value Hierarchy: the classification of valuation inputs and corresponding exposures into the Levels of the IFRS 13 fair value hierarchy, where level 3 exposures are those for which valuation is based on unobservable model input parameters;
  • Non-Performing Exposure (NPE) definitions: the definition of “Non-performing” relative to the EBA simplified approach for the AQR, including treatment of forborne assets;
  • Forbearance and Restructuring: the restructuring policy, definition, identification and tracking of forborne assets, including the implication on provisioning;
  • Provisioning processes and policies: the definition of “impaired”, appropriateness of impairment triggers, and policies and processes regarding the calculation of provisions;
  • Collateral Valuation and disposal processes: the processes regarding collateral valuation across collateral types and conservativeness of written policies;
  • Credit valuation adjustment calculation: the existence and coverage of the bank’s calculation of a credit valuation adjustment for derivatives;
  • Groups of connected clients and country of the ultimate borrower: the processes in place to identify connected clients, and determine the ultimate borrower’s country of risk.
  • Deconsolidation processes: the processes in place to decide when assets should be deconsolidated from the balance sheet
  • Reserves for legal costs: the approach the bank takes to defining reserves for litigation etc.

References

  1. ECB, Asset Quality Review - Phase 2 Manual

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