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Basel III credit risk standardized approach

Basel III Credit Risk – Standardized Approach.

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:

Item1st consultative document2nd consultative document
BankRisk 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 

CorporateSenior 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 LendingRisk 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

RetailRisk 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 estateRisk 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 estateRisk 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 exposuresRisk 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 assetsRisk 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%

MDBsRisk 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 – CCFRevisions to CCFRevisions to CCF
Currency mismatchSpecific add-on not mentionedAdd on of 50% to risk weight, subject to a maximum risk weight of 150%
Past due loans/ Defaulted exposuresPast 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

CRMRemoved 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 

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