Basel body eyes revisions for standard credit risks

MANILA, Philippines - The Basel Committee on Banking Supervision (BCBS) has released a consultative document on revisions to the standardized approach for credit risk.

The proposed revisions seek to strengthen the existing regulatory capital standard in several ways.

These include: reduced reliance on external credit ratings; enhanced granularity and risk sensitivity; updated risk weight calibrations, which for purposes of this consultation are indicative risk weights and will be further informed based on the results of a quantitative impact study; more comparability with the internal ratings-based (IRB) approach with respect to the definition and treatment of similar exposures; and better clarity on the application of the standards.

The committee also plans to replace references to external ratings, as used in the current standardized approach, with a limited number of risk drivers that provide a meaningful differentiation for risk.

These alternative risk drivers vary based on the particular type of exposure and have been selected on the basis that they are simple, intuitive, readily available and capable of explaining risk across jurisdictions.

Given the challenges associated with identifying risk drivers that can be applied globally, the committee recognizes that the proposals are still at an early stage of development. It must also reflect the local nature of some exposures, such as retail credit and mortgages.

Thus, the BCBS seeks respondents’ comments and data with a view to enhancing the proposals set out in this consultative document.

The key aspects of the proposals are:

• Bank exposures: would no longer be risk-weighted by reference to the bank’s external credit rating or that of its sovereign of incorporation, but would instead be based on two risk drivers: the bank’s capital adequacy and its asset quality.

• Corporate exposures: would no longer be risk-weighted by reference to the borrowing firm’s external credit rating, but would instead be based on the firm’s revenue and leverage. Further, risk sensitivity and comparability with the IRB approach would be increased by introducing a specific treatment for specialised lending.

• Retail category: would be enhanced by tightening the criteria to qualify for a preferential risk weight, and by introducing an alternative treatment for exposures that do not meet the criteria.

• Residential real estate: would no longer receive a 35-percent risk weight. Instead, risk weights would be based on two commonly used loan underwriting ratios: the amount of the loan relative to the value of the real estate securing the loan (ie the loan-to-value ratio) and the borrower’s indebtedness (ie a debt-service coverage ratio).

• Commercial real estate: two options are currently under consideration: (a) treating the exposures as unsecured with national discretion for a preferential risk weight under certain conditions; or (b) determining the risk weight based on the loan-to-value ratio.

• Credit risk mitigation where the framework would be amended by reducing the number of approaches, recalibrating supervisory haircuts, and updating the corporate guarantor eligibility criteria.

The BCBS also published a consultative paper “Capital floors: the design of a framework based on standardized approaches,” which sets out the proposed design of a capital floor framework based on standardized, non-internal modeled approaches.

The committee welcomes comments on all aspects of this consultative document and the proposed standards text, particularly on the design of the framework.