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Policy Advice on the Basel Iii Reforms: Credit Risk

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Policy Advice on the Basel Iii Reforms: Credit Risk POLICY ADVICE ON THE BASEL III REFORMS: CREDIT RISK STANDARDISED APPROACH AND IRB APPROACH Publication number | DATE 1 POLICY ADVICE ON THE BASEL III REFORMS: CREDIT RISK Contents List of tables 5 List of figures 6 Executive summary 9 1. Introduction 11 1.1 Standardised approach 12 1.2 IRB approach 14 1.3 Structure of this report 15 2. EU-specific SA-IRB consistency issues 16 2.1 Definition of SMEs 16 2.2 SME supporting factor 17 2.3 Infrastructure lending supporting factor 20 2.4 Treatment of equity exposures currently risk weighted under Article 49 of the CRR 22 2.5 Retail exposures 26 Definition of retail – use of EUR 1 million threshold 26 Implementation of the notion of transactors 31 2.6 Definition of commitment 33 3. The standardised approach 36 3.1 Due diligence and use of ratings 36 Enhanced due diligence requirements 36 Use of the external ratings approach 37 3.2 Exposures to non-central government public sector entities (PSEs) 38 Definition of PSEs 38 Reciprocity of treatment of PSEs in Article 116(4) of the CRR 39 3.3 Exposures to banks 40 Treatment of rated exposures to banks 40 Assumption of implicit government support 41 Definition of grades under the SCRA approach 43 Treatment of exposures to banks where the banks belong to the same institutional protection scheme (IPS) 44 Identification of short-term exposures to banks 45 3.4 Exposures to securities firms and other financial institutions 48 Reciprocity of treatment for securities firms and other financial institutions in third country jurisdictions 48 3.5 Exposures to corporates 49 Use of the external credit ratings assessment (ECRA) approach 49 2 POLICY ADVICE ON THE BASEL III REFORMS: CREDIT RISK The final Basel III provisions for specialised lending 56 3.6 Subordinated debt, equity and other capital instruments 58 Revised RW treatment 58 Treatment of equity holdings made pursuant to national legislated programmes (NLPs) 60 Treatment of equity exposures previously classified as high risk items 61 Treatment of equities that are recorded as a loan but arise from a debt/equity swap made as part of the orderly realisation or restructuring of the debt 62 Treatment of liabilities from which the return is linked to that of equities 63 Treatment of debt holdings 64 Treatment of equity exposures to central banks 64 Additional risk sensitivity in the equity exposure class 64 3.7 Retail exposures 66 Revised RW treatment 66 Granularity criterion and additional measures for ensuring diversification 67 3.8 Real estate exposures 69 Implementation of the loan-splitting (LS) approach versus the whole-loan (WL) approach 70 Implementation of hard test (HT) 73 Eligibility of property under construction 75 Valuation requirements 76 Cyclical effects of valuation requirements (value at origination vs. current value) 78 Additional indicators for RW assignment 80 Additional guidance on underwriting policies 81 Condition for exclusion from IPRRE treatment 82 Treatment of exposures where the servicing of the loan materially depends on the cash flows generated by a portfolio of properties owned by the borrower 84 Land acquisition, development and construction exposures – general treatment 85 Conditions for the application of 100% RW for certain land acquisition, development and construction (ADC) exposures 86 3.9 RW multiplier to certain exposures with currency mismatch 87 3.10 Off-balance sheet items 89 3.11 Other assets 93 Gold bullion backed by bullion liabilities 93 Residual value of leased assets 93 3.12 Credit risk mitigation framework (CRM) 94 Impact of the Basel III revisions to the current CRM framework 94 Targeted fixes to the current CRM framework (in line with the EBA CRM report) 96 4. The Internal Ratings Based Approach 108 4.1 Basel reform and modelling incentives 108 Change in the PPU philosophy 111 Reversal to less sophisticated approach: application of Article 149 113 Sovereign exposures 114 4.2 Specific recommendations 119 3 POLICY ADVICE ON THE BASEL III REFORMS: CREDIT RISK Quantitative impact study: main impacts of the different parts of the reform 119 Scope of modelling: migration 122 Impact on risk parameters – PD 129 Impact on risk parameters – LGD 133 Combined PD and LGD floors 142 Impact on risk parameters - CCF 144 Impact on risk parameters – effective maturity 149 Specialised lending exposures – high Volatility commercial real estate 154 Credit risk mitigation (CRM) 156 4.3 Recommendations for improvements of the existing IRB framework 178 Missing and misleading definitions 178 1.25 scaling factor on the asset value correlation coefficient for ‘large financial sector entities’ 189 Dilution risk 193 Exposure value – EL, IRB shortfall and excess 196 Calculation of realised LGD and realised CCF 199 Estimation of PD in the case of definitions of default applied at facility level 201 Continuous rating scale 203 Treatment of intragroup insurance 208 Previous opinions published by the EBA 209 4 POLICY ADVICE ON THE BASEL III REFORMS: CREDIT RISK List of tables Table 1: Regulatory treatment of exposures to SMEs: CRR, CRR2 and Basel III .............................. 18 Table 2: Percentage change in equity RWA (relative to total current SA RWA), by equity category .......................................................................................................................................................... 24 Table 3: The scope of application of the threshold for the definition of retail in the IRB and SA ... 27 Table 4: Calculation of the threshold for the definition of retail exposures .................................... 28 Table 5: RWA increase per exposure sub-class – retail (as a percentage of total current SA RWA) 33 Table 6: Exposure class banks : exposure amounts/unrated/IPS (as a percentage of total banks’ exposure amounts) .......................................................................................................................... 45 Table 7: Percentage change in SA of exposure to banks (relative to total current SA RWA), by sub- class and maturity ............................................................................................................................ 46 Table 8: Exposure class corporates (excluding SMEs): exposure amounts by rated/unrated ......... 49 Table 9: Exposure class corporate SMEs: exposure amounts by rated/unrated ............................. 50 Table 10: Exposure class Specialised Lending: exposure by sub-exposure class ............................. 57 Table 11: Percentage change of SA RWA per exposure sub-class – Specialised lending (relative to total SA RWA) ................................................................................................................................... 57 Table 12: Percentage change of SA RWA per exposure sub-class – Equity (relative to total SA RWA) .......................................................................................................................................................... 59 Table 13: Risk weights applicable to equity exposures during the phased-in implementation of the Basel standards ................................................................................................................................ 59 Table 14: Percentage change in equity RWA (relative to total current SA RWA) during the phased- in implementation period ................................................................................................................ 59 Table 15: Exposure class Retail - exposure by sub-exposure class .................................................. 66 Table 16: Percentage change of SA RWA per exposure sub-class – Retail (relative to total SA RWA) .......................................................................................................................................................... 67 Table 17: Real estate exposure class – the final Basel III framework .............................................. 69 Table 18: Percentage change of SA RWA per exposure sub-class – Exposures secured by real estate (relative to total SA RWA) ..................................................................................................... 69 Table 19: Scenarios specification for real estate exposures ............................................................ 72 Table 20: List of changes from the final Basel III framework and applicability to central government and central bank exposures ...................................................................................... 116 Table 21: Sample size for the marginal scenario ............................................................................ 121 Table 22: observed impact of the RGLA and PSE exposures depending on their classification .... 128 5 POLICY ADVICE ON THE BASEL III REFORMS: CREDIT RISK Table 23: Thresholds used in the corporate exposure class .......................................................... 151 Table 24: Thresholds in place for the use of the fixed value of M ................................................. 152 Table 25: Alternative thresholds proposed for the use of the fixed value of M ............................ 153 Table 26: Change of RW-function for exposures under A-IRB ....................................................... 167 Table 27: Summary of proposals related to missing or unclear definitions in the CRR ................. 183 Table 28: Impact on the RW from the scaling factor on the asset value correlation coefficient .. 192 Table 29: Proposed application of the scaling factor ....................................................................
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