Credit risk

Credit risk is the risk of loss to UBS as a result of failure by a client or counterparty to meet its contractual obligations. It is an integral part of many of our business activities and is inherent in traditional banking products – loans, commitments to lend and contingent liabilities, such as letters of credit – and in “traded products_ – derivative contracts such as forwards, swaps and options; repurchase agreements (repos and reverse repos); and securities borrowing and lending transactions.

Some of these products are accounted for on an amortized cost basis while others are recorded in the financial statements at fair value. Banking products are generally accounted for at amortized cost, but loans which have been originated by UBS for subsequent syndication or distribution via the cash markets are carried at fair value. From second quarter 2006, UBS will also adopt the fair value option available under IAS39 for new loans and commitments where credit risk is substantially hedged with credit default swaps. Within traded products, OTC derivatives are carried at fair value, while repos and securities borrowing and lending transactions are carried at amortized cost. Regardless of the accounting treatment, all banking and traded products are governed by the same risk management and control framework - the Group Credit Policy Framework and our detailed credit policies and procedures.

Global Wealth Management & Business Banking and the Investment Bank, which take material credit risk, have independent credit risk control units, headed by Chief Credit Officers (CCOs) reporting functionally to the Group CCO. They are responsible for counterparty ratings, credit risk assessment and the continuous monitoring of counterparty and portfolio credit exposures. Credit risk authority, including authority to establish allowances, provisions and valuation adjustments for impaired claims, is vested in the Chairman’s Office and the GEB, and from there is delegated ad personam to the Group CCO and credit officers in the Business Groups. The level of credit authority delegated to holders varies according to the quality of the counterparty and any associated security, and takes into account the seniority and experience of the individual.