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Summary of the Italian Factoring Industry's Contribution to the CEBS Questionnaire on Large Exposures

Core Content

The document outlines the Italian factoring industry's perspective on the measurement and management of concentration risk, particularly in relation to the CEBS questionnaire on large exposures. It is presented by Assifact, the Italian Factoring Association, summarising the views of its members on how concentration risk is assessed and mitigated in the context of factoring operations.

Main Views

General Approach to Concentration Risk

• Financial intermediaries in the Italian factoring industry follow national regulations on prudential supervision, which define "large exposures" as those equal to or exceeding 15% of regulatory capital.
• The overall limit for large exposures is set at eight times the regulatory capital, while the single name limit is 60% of regulatory capital.
• The Supervisory Authority (Bank of Italy) monitors these limits through quarterly reporting by financial intermediaries.
• Internal risk measurement approaches are developed based on the specific nature of factoring activities, which involve the purchase of trade receivables and the provision of financial and management services.

Nature of Concentration Risk

• Concentration risk arises from the high exposure relative to regulatory capital, particularly with individual clients or connected groups.
• There are two types of connections:
  • Juridical connection: when one client controls another.
  • Economic connection: when financial stress of one client adversely affects another.
• Despite structural concentration in terms of assignors, the assigned debtors are often fragmented, reducing the risk of systemic exposure.
• The risk level in factoring is modest compared to traditional loan portfolios, due to detailed monitoring and specific risk assessment methods.

Measurement of Exposures

• Exposure is measured as the sum of risk assets, adjusted for the risk profile of the debtor and any guarantees.
• The IRB method (Internal Rating-Based) is expected to offer a more accurate measurement aligned with the specific nature of factoring operations.

Principal Risk Counterparty

• In factoring, the debtor is typically the main risk counterparty, as they are responsible for repayment.
• In non-recourse factoring, the transferor may bear the credit risk.

Risk Monitoring and Management

• Financial intermediaries use both regulatory frameworks and internal tools to monitor concentration risk at both single position and segment levels.
• Periodic reports are prepared to identify "large risk" positions and sector concentrations, enabling timely control and reduction measures.

Credit Risk Mitigation Techniques

• Insurance policies are increasingly used to mitigate credit risk.
• Two main types of insurance are identified:
  • Analytical insurance policies: cover individual credit lines, with the insurer's liability limited to the credit lines accepted.
  • Excess loss insurance policies: operate at the portfolio level, covering losses exceeding a certain threshold (aggregate excess), usually aligned with expected losses.
• These policies help stabilise the risk profile and provide a buffer against unexpected losses.
• Additional techniques include:
  • Setting credit ceilings.
  • Charging additional commission ("malus") in case of risk retention.

Regulatory Environment

• Current regulations apply standard limits to all financial intermediaries, regardless of their activity, leading to generic indicators that do not reflect the specific nature of factoring.
• The concentration index is based on the ratio between nominal exposures and regulatory capital, but it aggregates exposures of different natures (short, medium, long-term, etc.), making it inadequate for assessing factoring-specific risks.
• The application of the concentration index to specialised activities like factoring may penalise them unfairly and distort competition.
• It is argued that regulations should be differentiated by the type of activity and intermediary, to ensure the meaningful application of the index to homogeneous groups.

Key Information

• Factoring involves purchase of trade receivables, typically short-term, from long-term client relationships.
• Diversification is achieved through geographic, sectoral, and product-based segmentation.
• The solidity of the financial intermediary is not significantly affected by debtor concentration, as default may be isolated to the underlying supply relationship.
• Insurance is a key tool for credit risk mitigation, with analytical and excess loss policies being the most common.
• Regulatory adjustments are needed to better reflect the specific risk profile of factoring operations.

Conclusion

The Italian factoring industry highlights the distinctive nature of its activities and the effectiveness of its risk management practices, which differ from those of traditional financial institutions. It advocates for tailored regulatory frameworks that consider the specific features of factoring, such as the presence of a second counterparty, short-term exposures, and risk mitigation tools like insurance.