The Basel III standard issued by BIS has been up for discussion and debate. BIS issued a first consultative paper on the revisions to the standardized approach to credit risk in December 2014. A second consultative paper was issued on 10th December 2015. We present a brief comparison of the marked differences between the two documents. The big news is that external ratings are back in fashion in the second document and all the interesting work being done on including borrower leverage ratios has been rolled back.
Comparison of the 1st and 2nd consultative document
The major changes proposed in the 1st and 2nd consultative papers are summarized below:
| Item | 1st consultative document | 2nd consultative document |
| Bank | Risk weights based on
· Capital adequacy (CET1 ratio as per Basel III) · Asset quality rate (Net NPA ratio) 300% risk weight to be applied if information is unavailable Preferential risk weights for exposures with original maturity of <= 3 months |
“Base” risk weights based on
· External ratings[1], subject to due diligence OR · Standard risk ratings based on whether the entity satisfies minimum capital requirements and buffers and published by the national supervision in the jurisdiction of the borrowing bank Preferential risk weights for exposures with original maturity of <= 3 months |
| Corporate | Senior corporate debt exposure
Risk weights based on · Leverage (Total Assets/Total Equity) · Revenue Based on year end accounts for the most recent financial year 300% risk weight to be applied if information is unavailable |
“Base” risk weights based on
· External ratings, subject to due diligence OR · Meets conditions for investment grade o 75% o Otherwise 100% for all other corporate exposures o 85% for SMEs treated as corporate exposures |
| Specialized Lending | Risk weight of 120% for
· Project finance · Object finance · Commodity finance Risk weight of 150% for land acquisition, development and construction |
Risk weights based on
· Issue specific external ratings, OR · Flat risk weights as follows: o Object finance = 120% o Commodity finance = 120% o Project finance (pre-operational) = 150% o Project finance (operational) = 100% Risk weight of 150% for land acquisition, development and construction |
| Retail | Risk weights as follows:
· Regulatory retail =75% · Other retail = 100% · SME not meeting regulatory retail conditions will be treated as corporate exposures |
Risk weights as follows:
· Regulatory retail =75% · Other retail = 100% · SME not meeting regulatory retail conditions will be treated as corporate exposures |
| Residential real estate | Risk weights based on:
· Loan to value (LTV) ratio · Debt-service coverage ratio |
Risk weights based on:
Non income producing (general) real estate · Loan to value (LTV) ratio if operational requirement met · 100%, other wise Income producing real estate · Loan to value (LTV) ratio if operational requirement met (RWs higher than for general residential real estate) · 150%, other wise |
| Commercial real estate | Risk weights based on either
· Counterparty type OR · LTV ratio |
Risk weights based on:
Non income producing real estate, if operation requirements are met · Min of (60% and RW of counterparty) if LTV <=60% · RW of counterparty, other wise Non income producing real estate, if operation requirements are not met · Max of (100% and RW of counterparty) Income producing real estate · Loan to value (LTV) ratio if operational requirement met (RWs higher than for income producing residential real estate) · 150%, other wise |
| Equity & subordinated debt exposures | Risk weights are as follows:
· Equity (that not deducted from regulatory capital) o publicly traded on a recognised security exchange =300% o all other = 400% · Subordinated debt =250% |
Risk weights are as follows:
· Equity (that not deducted from regulatory capital) = 250% · Subordinated debt (which do not get 250% for regulatory capital) = 150% |
| Other assets | Risk weight of 100% | Risk weight of 100%, except as follows:
· cash owned and held at the bank or in transit = 0% · gold bullion held at the bank or held in another bank on an allocated basis, to the extent the gold bullion assets are backed by gold bullion liabilities = 0% · cash items in the process of collection = 20% |
| MDBs | Risk weights will be as follows:
· Eligible MDBs = 0% · Qualifying MDBs= current MDB risk weights based on external ratings · Other MDBs treated as corporate exposures |
Risk weights will be as follows:
· Eligible MDBs = 0% · Other MDBs = current MDB risk weights based on external ratings, and for unrated MDBs or where external ratings are not permissible, 50% |
| Off-balance sheet exposures – CCF | Revisions to CCF | Revisions to CCF |
| Currency mismatch | Specific add-on not mentioned | Add on of 50% to risk weight, subject to a maximum risk weight of 150% |
| Past due loans/ Defaulted exposures | Past due loans:
Alternatives suggested · Add-on OR · Flat risk weights No values specific for either |
Defaulted exposure:
· Applies to all assets not just loans · Risk weights delinked from the amount of provision held · 100% risk weight on unsecured portion of general residential real estate exposure · 150% risk weight on unsecured portion of other exposures |
| CRM | Removed use of own estimates for haircuts, VaR models and Internal Model Method for SA
Can only use supervisory haircuts Haircuts revised Eligible collateral revised Eligible guarantors revised Removed use of external ratings |
Removed use of own estimates for haircuts, VaR models and Internal Model Method for SA
Can only use supervisory haircuts Haircuts revised Eligible collateral revised Eligible guarantors revised Retained external ratings with alternative treatment where external ratings are unavailable or cannot be used |
[1] If available and where allowed for regulatory purposes