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elimination of the net income target and in a more accurate estimation of the Bank’s risk exposure. The policy has been effective in achieving the proposed objectives. A policy was defined in a risk based framework, greater stability was achieved in loan charges compared to previous periods, and the TELR reached its medium term target of 38% even earlier than planned (although this was largely due to a decrease in lending. 6.4
The main financial impact was the elimination of the net income target (ICR) for setting loan charges. Elimination of that target has permitted higher loan charges than those that would have been set under the previous policy. Another financial impact was the better perception of the Bank by the rating agencies, although the capital policy was not a crucial factor in maintaining the AAA credit rating.
6.5
The main operational impact is the difficulty in reaching consensus regarding appropriate loan charges now that the capital adequacy measure has exceeded the range defined by policy. In this environment, the Board needs information beyond that provided by the level of capital in order to make good strategic decisions on loan charges.
B.
Recommendations
6.6
The capital adequacy policy has worked well during the first three years of its application; it has achieved most of its main objectives, and has the virtue of being well understood by the Bank’s shareholders. However, in the context of the Bank’s evolving business model, there are some areas in which some improvements could be considered.
6.7
The credit risk model is the result of a development effort that should be a permanent activity. Accordingly, the necessary resources should be assigned for the model to be permanently updated and based on the most recent experience and developments in risk management and information technology. To move in that direction, the following recommendations are made: (i) explore the possibility of using new sources for calibrating the probabilities of default, and (ii) explore the possibility of migrating to a conditional model that explicitly incorporates macroeconomic and/or financial variables for each country. Furthermore, tighter coordination is recommended between the areas responsible for development of the model and the Bank’s Research Department. Finally, improvements in the model’s standards of documentation are also recommended.
6.8
Linking the loan charges to the TELR has helped produce the desired stability and has rapidly strengthened the Bank’s capital position. However, in the current circumstances, with a TELR above 38%, the current policy does not provide sufficient guidance for the Board to exercise its discretion in setting loan charges. In this new context, and given more competitive capital markets, the Bank could consider separating the capital adequacy and loan charge policy into two separate policies.