This consultation document aims to revise the standardized approach for credit risk by considering feedback from stakeholders on the initial proposals. The new proposals seek to balance simplicity and risk sensitivity while reducing variability in risk-weighted assets across banks and jurisdictions. It is also proposed to reintroduce external credit ratings in a non-mechanistic manner for exposures to banks and…
This document is the second consultative paper published in December 2015 by the Basel Committee on Banking Supervision. It concerns the proposed revisions to the standardized approach (SA) for credit risk within the banking regulatory framework. The scope covers exposures to banks, corporates, specialised lending, retail portfolios, real estate exposures, defaulted exposures, off-balance sheet items, multilateral development banks, and other assets. The document comprises approximately 68 pages, of which only the first 27 pages were provided for this summary. The consultation was open until 11 March 2016 (p. 1-27).
The document addresses the revision of the standardized approach for credit risk, aiming to improve risk sensitivity, comparability, and reduce mechanical reliance on external ratings. This topic is crucial as the standardized approach serves as a global minimum floor for capital requirements, impacting financial stability and competition among banks and jurisdictions. Key findings are:
- The initial proposal to fully remove external ratings for exposures to banks and corporates received criticism for complexity and lack of risk sensitivity.
- The Committee therefore proposes to reintroduce external ratings in a non-mechanical manner, with enhanced due diligence requirements to avoid blind reliance.
- For jurisdictions not permitting the use of ratings, an alternative system classifying exposures into three grades (A, B, C) is proposed.
- For real estate exposures, the loan-to-value (LTV) ratio is retained as the main risk factor, differentiating whether repayment depends on cash flows generated by the property.
- Defaulted exposures will be aligned with the IRB definition of default, with a 150% risk weight for the unsecured portion.
- The credit risk mitigation framework is simplified by removing internal approaches and reintroducing ratings for defining guarantees and collateral.
The conclusions emphasize that these proposals balance simplicity, risk sensitivity, and comparability, while reducing discrepancies between jurisdictions. The Committee recommends continuing consultations and data collection through a new quantitative impact study (QIS) to refine calibrations. Stakeholders are invited to comment notably on macroeconomic context consideration, exposure definitions, and due diligence implementation (p. 5-27).
This document follows a first consultation in 2014 on the revision of the standardized approach for credit risk. The objective is to address received criticisms, notably on the full removal of external ratings, deemed excessive. The Committee aims to design an approach that is simple, risk-sensitive, comparable across banks and jurisdictions, and limits mechanical reliance on rating agencies. The scope excludes sovereign, central bank, and public entity exposures, which will be reviewed separately. Limitations include the complexity of integrating all national specificities into a standardized approach and the need to balance complexity and risk sensitivity. The document presents revised proposals for exposures to banks, corporates, specialised lending, retail portfolios, real estate, defaulted exposures, off-balance sheet items, multilateral development banks, and other assets, as well as for the credit risk mitigation framework (p. 5-7, 22-23, 26-27).
Exposures to banks:
- Introduction of a hierarchy of approaches for credit risk:
- ECRA (External Credit Risk Assessment) for rated exposures in jurisdictions permitting ratings, with due diligence possibly leading to a higher risk weight than the rating.
- SCRA (Standardised Credit Risk Assessment) for unrated exposures or in jurisdictions not permitting ratings, classifying exposures into grades A, B, or C based on precise financial and regulatory criteria.
- Retention of a preferential treatment (50%) for banks exceeding regulatory requirements and buffers.
- Risk weights of 50%, 100%, or 150% depending on grade and default status.
Exposures to corporates:
- Two approaches depending on rating permission:
- With rating: risk weight based on external rating, possible due diligence.
- Without rating: 75% risk weight for so-called "investment grade" corporates, 100% otherwise.
- SME exposures weighted at 85%, justified by lower asset correlation and better unrecognized collateral.
Specialised lending:
- Reintroduction of external ratings for certain specialised loans.
- Specific risk weights: 120% for object and commodity finance, 150% for pre-operational project finance, 100% in operational phase.
- Reclassification of specialised real estate loans into the real estate class.
Retail portfolio:
- Explicit definition of retail portfolio as exposures to individuals and SMEs.
- Retention of a flat 75% risk weight for regulatory retail exposures.
- Non-eligible retail exposures weighted at 100%.
Real estate exposures:
- Grouping all real estate exposures (residential, commercial, ADC) into one class.
- Use of the LTV ratio as the main risk factor.
- Differentiation based on whether repayment depends on cash flows generated by the property.
- Risk weights from 35% to 100% depending on LTV for residential, preferential or counterparty-quality-based weights for commercial.
- ADC weighted at 150%.
Defaulted exposures:
- Alignment with the IRB definition of default.
- 150% risk weight for unsecured portion, 100% for residential not dependent on property cash flows.
- Removal of the link between specific provisions and risk weight.
Off-balance sheet exposures:
- Application of a positive credit conversion factor (CCF) to unconditionally cancellable commitments, limited to retail commitments (10-20%).
- Alignment of other commitments’ CCFs with foundation IRB approach (50-75%).
Credit risk mitigation (CRM):
- Removal of internal and own-estimate approaches for capital requirement calculation.
- Reintroduction of external ratings to define collateralisation and guarantees.
- Proposal of a revised formula for repo-type transactions considering diversification and correlation.
Other points:
- Retention of 0% treatment for AAA-rated multilateral development banks (MDB), with flexibility to maintain a minimum AA(-) rating.
- Clarification and retention of a residual "other assets" category with some technical adjustments.
- Discussion on the need for increased disclosures to ensure market discipline and comparability.
- Exclusion of government support consideration in bank ratings.
- Invitation to comment on country risk consideration in unrated approaches.
(p. 3-27)
Findings:
- The full removal of external ratings for exposures to banks and corporates was deemed inappropriate by respondents.
- The use of the loan-to-value (LTV) ratio is a relevant and robust risk factor for real estate exposures.
- Defaulted exposures require a harmonized definition aligned with the IRB approach.
- Unconditionally cancellable off-balance sheet commitments carry non-zero risk, justifying a positive CCF.
Assumptions:
- Banks’ due diligence will limit mechanical reliance on ratings.
- Classification into grades A, B, C for unrated exposures adequately reflects risk.
- The absence of DSC ratio consideration in residential real estate exposures is compensated by a requirement to assess repayment capacity.
Interpretations:
- The reintroduction of external ratings combined with enhanced due diligence balances risk sensitivity and simplicity.
- Alignment of definitions and risk weights with the IRB approach promotes comparability and consistency.
Uncertainties:
- The precise impact of new risk weights on capital requirements remains to be calibrated via the QIS.
- Effective implementation of due diligence and comparability between jurisdictions using or not using external ratings.
- Acceptability and feasibility of excluding government support in bank ratings.
(p. 5-27)
The Committee concludes that the revised proposals address criticisms raised during the first consultation by reintroducing external ratings in a non-mechanical manner and strengthening due diligence requirements. It recommends continuing the consultation until 11 March 2016 and collecting data through a new quantitative impact study (QIS) to refine calibrations. The Committee emphasizes that the standardized approach remains a global minimum standard and that national supervisors may impose more conservative treatments if necessary. It also plans to assess implementation modalities, including transitional provisions, to facilitate adoption of the revisions amid multiple reforms. Finally, the Committee invites comments on the proposals, notably regarding country risk consideration, exposure definitions, and management of risks related to credit derivatives. (p. 5-7, 22-27)
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