Proposed BCBS Standardized Approach for Credit Risk 1 BANK, CORPORATE, RETAIL, AND OFF- BALANCE- SHEET EXPOSURES
Due Diligence Requirements Firms must understand and assess at least annually counterparty risk profile and characteristics 2 Expectation of firms: demonstrate to supervisor that internal policies, processes, systems and controls are in place to ensure appropriate risk weights are assigned to counterparties Expectation of supervisors: impose supervisory measures where firms have not performed necessary due diligence Ratings-based approaches for claims on banks and corporates: if the due diligence analysis reflects higher risk characteristics than that implied by the exposure s external rating, the bank must assign a risk weight at least one bucket higher than the base risk weight.
Claims on Banks Current Basel SA: RW based on bank s credit rating or the credit rating of its sovereign 2014 Proposal: would have replaced ratings with a bank s CET1/RWA ratio and net non-performing assets (net NPA) ratio 2015 Proposal: Jurisdiction specific; Grades determined by ability to meet minimum regulatory capital requirements; Preferential treatment for short-term exposures Jurisdiction specific RW differences minimized 3
Unrated Claims on Banks: Standardized Credit Risk Assessment (SCRA) 4 Grade A counterparties: Capacity to meet financial commitments on timely basis for life of exposure irrespective of economic cycle and business conditions Exceed the published minimum regulatory requirements and buffers established by national supervisor Grade B counterparties: Subject to substantial credit risk; repayment capacity dependent on stable/favorable economic/business conditions Meets published minimum regulatory requirements (but not buffers) Grade C counterparties: Material default risks; adverse business, financial, or economic conditions likely to result in inability to meet financial commitments Breached minimum regulatory capital requirements For audited firms, external auditor has within last year expressed substantial doubt about firm s ability to continue as going concern Potential sovereign risk-weight floor subject to consideration
Corporate Exposures: General Loans & Senior Debt Current Basel SA: RW based on credit ratings 5 2014 Proposal: would have replaced credit ratings with a measure of corporate obligor s leverage and total revenue (i.e., a proxy for size) 2015 Proposal: Jurisdiction specific; Compromise achieved for c0untries that don t use ratings RW table in jurisdictions where ratings can be referenced RW table in jurisdictions where ratings cannot be referenced Jurisdictions that cannot use external ratings for regulatory purposes Credit Risk Assessment of counterparty Investment Grade Non-Investment Grade "Base" risk weight 75% 100% 85% RW for Small and Medium Enterprises (SMEs)
Corporate Treatment: Jurisdictions that Do NOT Reference Credit Ratings 75% RW for investment grade corporate exposures Investment grade if exposure has capacity to meet financial commitments on timely basis, irrespective of the economic cycle and business conditions 6 Considers complexity of entity s business model, performance against industry/peers, risks posed by entity s operating environment Corporate entity (or its parent company) must have securities outstanding on a recognized securities exchange This language serves to better ensure the investment-grade corporates are generally externally rated
Corporate Exposures: Specialized Lending Current Basel SA: Flat 100% RW 2014 Proposal: flat RWs proposed for five subcategories of specialized lending (SL) (including ADC and IPRE) 2015 Proposal: Applies to object, project and commodities finance; ADC and IPRE moved to real estate section; Jurisdiction specific treatment Externally rated SL utilize general corporate treatment 7 For unrated SL or all SL where banks cannot reference ratings Object and Project Finance - Pre Project Finance - Specialized Lending Exposure Type Commodities Finance Operational Post Operational "Base" risk weight 120% 150% 100%
Equity & Subordinated Debt Exposures Current Basel SA: Equities and most other capital instruments receive a flat 100% RW 2014 Proposal: Publicly traded equity exposures receive a 300% RW All other equity exposures receive a 400% RW Subordinated debt receives a 250% RW 2015 Proposal: Equity exposures receive a 250% RW Subordinated debt receive a 150% RW 8
Retail Exposures (non-mortgage) 9 Current Basel SA: 75% RW for the majority of retail exposures (including credit cards, auto loans, and small business loans) As long as exposures comply with definition of regulatory retail, including orientation criterion, product criterion, granularity criterion and low value of individual exposures ( 1 million threshold). 2014 and 2015 Proposals: Minor changes from current SA Granularity criterion: introduce explicit 0.2% numerical limit as binding minimum supervisory standard with national discretion to remove it, when a supervisor has implemented other methods to ensure diversification Orientation criterion: clarifies that retails exposures must be to individual persons or to SMEs (small business, which is undefined, is removed). Background & Justification: Following risk drivers considered: (1) Length of relationship with the client; (2) Debt service coverage (DSC) ratio; (3) Maturity; (4) Secured and unsecured lending; and (5) revolving vs. non-revolving Data collection and industry comment did not provide sufficient evidence to justify alternative approaches
Off-Balance Sheet Exposures Current SA and Proposed Revisions: 10 increase credit conversion factors (CCFs) for unconditionally cancellable commitments (UCCs) and general commitments (no differentiation for maturity). Only retail commitments qualify as UCCs
Commitments Justification for increased CCFs UCCs carry drawdown risks (i.e., should not be 0% CCF); More consistent with leverage ratio Retail UCCs exhibit less drawdown risk than corporate UCCs A commitment s maturity is often rolled-over Commitment defined to narrow range of practices 11 Any contractual arrangement accepted by the client52 whereby the bank is committed to extend credit, purchase assets or issue credit substitutes Proposal may have most significant impact because: Any increase from 0% will be substantial for credit card lenders CCFs have knock-on effects to leverage ratio, large exposure rule, etc.
Defaulted Exposures 12 Current Basel SA: Past Due RWs generally range between 100% & 150%, depending on levels of specific provisions. 2014 Proposal: no proposed changes 2015 Proposal: Replace Past Due Exposure with Defaulted Exposure, generally consistent with the IRB definition of default. Impose a flat 150% RW for all defaulted exposures (except certain residential real estate exposures) No longer differentiate RW by specific provisions; because specific provisions (and charge-offs) already decrease the exposure amount, they shouldn t provide any additional benefit when assigning RWs.