CLASSIFICATION OF LENDING PRODUCTS AND BASEL 2 CRITERIA
Basel 2 uses the term "exposure" for designating transactions, or, equivalently, facilities in banking terminology. The term "exposure" refers to the credit risk to which transactions are exposed.
Basel 2 differentiates products based on asset classes, defined by type of counterparty (corporation, sovereign, bank, individual) and in some cases on product characteristics. Basel 2 regulations segregate transactions according to "capital treatment." The asset class is the starting point for implementing capital charge calculations, or "capital treatment." Hence, asset classes are not entirely defined by pure credit risk criteria, but serves for defining "eligibility" to the various capital treatments allowed under Basel 2. In spite of some differences, capital treatment follows generally accepted principles for dealing with credit risk.
If we refer to economic and risk management criteria, the common terminology differs from Basel 2 classification. Lending differs according to whether it is secured or unsecured, whether it is collateral based or not, and whether the risk is more transaction-specific than borrower based. A secured transaction benefits from guarantees, which are named "credit risk mitigants" in Basel 2. All guarantees are generally transaction-specific.
Unsecured lending is therefore primarily credit standing based. Secured lending depends on both borrower's credit standing and transaction-specific guarantees. Many secured transactions have a lower credit risk than the borrower because of the guarantees attached. A transaction can be secured by collateral pledged to the lender or by third party guarantees, or contracts that transfer the credit risk to the guarantor.
Specialized lending is mainly transaction-specific because lending is primarily backed by the transaction collateral and the terms of lending contract, which make up a "term sheet" assembling a variety of contractual clauses that protect the borrowers.
In the definition of lending products, we frequently use the Basel 2 definitions, because they are both comprehensive and specific. The reference document is "International Convergence of Capital Measurement and Capital Standards - A Revised Framework, Comprehensive Version" , of which several excerpts are used here. The paragraph references in the text are the references of this document.
Basel 2 uses broad classes of assets with different underlying risk characteristics. Except for the equity asset class, which relates to the nature of the instrument (equity), other asset classes are by type of counterparty. The five main Basel 2 asset classes are:
• retail: individuals and small and medium-sized enterprises (SMEs)
Within the corporate asset class, five sub-classes of "specialized lending" are separately identified. Within the retail asset class, three sub-classes are separately identified. The sub-classes are described in subsequent sections.