Comparative Study on the Determination of Counterparty Credit Limit Risk in Indonesian Banks

Abstract

A counterparty credit limit is a limit imposed by a financial institution to cap its maximum possible exposure to a specified counterparty. Banks may set different counterparty credit limits depending on credit quality, potential earnings, and growth. They use this criterion to provide a maximum credit limit given to correspondent banks. The counterparty credit limit will be used in various financial instruments other than loans; this includes interbank transactions, foreign exchange transactions, trade financing, acceptances, financial futures, swaps, bonds, equities, options, extension commitments, and guarantees, and the settlement of transactions. Every Bank, regardless of size, is in business to be profitable and, consequently, must determine the acceptable risk/reward trade-off for its activities, factoring in the cost of capital. Therefore, the credit line allocation is unadvised and uncommitted to the corresponding Bank based on the correspondent bank's credit risk assessment.

The result shows that the significance (Sig) is less than 0.05; this indicates differences in measuring the probability and impact dimension of setting the counterparty credit limit risk. The risk includes not making visits to counterparties, not responding to counterparty requests for opening a relationship as a customer or correspondent bank, misjudging the counterparty's business potential, mistakes in analysing counterparty management (owner of correspondent bank (UBO), management and organizational structure, KYC/AML needs), mistakes in analysing macroeconomics and the banking industry that have an impact on counterparties (global economy, changes in monetary authority regulations or regulations, changes in government regulations), wrong in analysing counterparty business risk (portfolio composition, customer segment, correspondent bank strategy), wrong in analysing counterparty financial performance (balance sheet analysis, R/L report, financial ratio), wrong in setting counterparty rating, incorrect calculation of counterparty limits (formulation of limits and bank capital), wrong in allocating counterparty limit (transaction risk weight & business target based on projections), mistakes in analysing the projected counterparty capability for a period of more than 1 year, not monitoring counterparty limit utilization,  does not monitor counterparty financial performance (review limit in 1 period only), not monitoring and paying attention to sanctions or legal cases that occur to counterparties, not limiting and monitoring all ongoing transactions using counterparty limits, does not limit the tenor/transaction period, provide a limit even though the process of determining the counterparty limit has not been completed, and not doing due diligence on a regular basis. Ideally, all banks in Indonesia ought to have the same perspective in assessing the counterparty credit limit. This study showed that Indonesian banks should be encouraged to develop an effective strategy to improve their counterparty credit risk assessment. To further improve, policymakers can generate appropriate policies to govern the Bank's behavior in mitigating risk.