Superseded document Basel Committee on Banking Supervision Consultative Document The Internal Ratings-Based Approach Supporting Document to the New Basel Capital Accord Issued for comment by 31 May 2001 January 2001 Superseded document Table of Contents CHAPTER 1: OVERVIEW AND ORIENTATION OF IRB APPROACH.................................................1 I. INTRODUCTION ........................................................................................................................ 1 II. ORIENTATION OF THE IRB APPROACH................................................................................ 3 III. SIMPLE SCHEMATIC OF IRB APPROACH ............................................................................. 4 A. CATEGORISATION OF EXPOSURES .................................................................................................. 5 B. RISK COMPONENTS ....................................................................................................................... 5 (i) Probability of Default .............................................................................................................. 6 (ii) Loss Given Default ................................................................................................................. 6 (iii) Exposure at Default (EAD) ..................................................................................................... 6 (iv) Maturity................................................................................................................................... 7 C. RISK WEIGHTS .............................................................................................................................. 7 D. MINIMUM REQUIREMENTS .............................................................................................................. 7 (i) Adherence to minimum requirements .................................................................................... 7 CHAPTER 2: IRB FRAMEWORK FOR CORPORATE EXPOSURES...................................................9 I. DEFINITION OF CORPORATE EXPOSURES.......................................................................... 9 II. RANGE OF PRACTICE.............................................................................................................. 9 A. THE NUMBER OF GRADES BOTH FOR PERFORMING AND NON-PERFORMING LOANS............................. 9 B. THE DECISION WHETHER TO FOCUS THE RATING ON THE BORROWER OR THE FACILITY .................... 10 C. THE MEANS BY WHICH RATINGS ARE ASSIGNED ............................................................................. 10 D. THE RISK FACTORS CONSIDERED IN THE RATING ASSIGNMENT PROCESS ........................................ 11 E. THE TIME HORIZON OVER WHICH THE RATING IS CONSIDERED A VALID RISK INDICATOR .................... 12 F. USE OF INTERNAL RATINGS .......................................................................................................... 12 III. RISK COMPONENTS............................................................................................................... 13 A. OVERVIEW .................................................................................................................................. 13 B. PROBABILITY OF DEFAULT (PD) ................................................................................................... 15 (i) Average PD per grade.......................................................................................................... 15 (ii) One year PD......................................................................................................................... 16 (iii) Methods for quantifying PD .................................................................................................. 16 (iv) Impact of credit derivatives and guarantees on estimation of PD........................................ 16 C. LOSS GIVEN DEFAULT (LGD) ...................................................................................................... 18 (i) Foundation approach............................................................................................................ 19 (ii) LGD under the advanced approach ..................................................................................... 21 D. EXPOSURE AT DEFAULT .............................................................................................................. 22 (i) Transactions with uncertain future drawdown...................................................................... 23 (ii) OTC derivatives.................................................................................................................... 24 E. MATURITY................................................................................................................................... 25 (i) Introduction........................................................................................................................... 25 (ii) Treatment of maturity under the foundation IRB approach .................................................. 26 (iii) Treatment of maturity under the advanced IRB approach ................................................... 27 (iv) Definition of ‘effective maturity’............................................................................................. 27 (v) Information required by banks.............................................................................................. 28 F. DISCUSSION ON DEFINITION OF DEFAULT ......................................................................................... 29 (i) Current practice for corporate exposures............................................................................. 29 (ii) Reference definition of default.............................................................................................. 30 (iii) Prospects of a “mapping” for estimates based on other definitions ..................................... 31 IV. RISK WEIGHTS FOR CORPORATE EXPOSURES ............................................................... 31 A. DETERMINATION OF RISK WEIGHTED ASSETS ................................................................................ 31 Superseded document B. FORMULA FOR RWA FOR CORPORATE EXPOSURES ...................................................................... 32 C. CALIBRATION OF BENCHMARK RISK WEIGHTS FOR CORPORATE EXPOSURES ................................... 33 (i) Introduction........................................................................................................................... 34 (ii) Survey-based evidence........................................................................................................ 35 (iii) Direct estimates of risk weights............................................................................................ 35 D. MATURITY-ADJUSTMENTS TO CORPORATE RISK WEIGHTS .............................................................. 36 (i) Maturity-adjustments based on MTM approach................................................................... 37 (ii) Maturity-adjustments based on adjusted DM approach....................................................... 38 E. EXPECTED LOSS AND THE DETERMINATION OF CORPORATE RISK WEIGHTS ..................................... 40 V. MINIMUM REQUIREMENTS FOR CORPORATE EXPOSURES UNDER THE FOUNDATION APPROACH ................................................................................................................... 41 A. INTRODUCTION............................................................................................................................ 41 B. CRITERIA TO ENSURE MEANINGFUL DIFFERENTIATION OF RISK ....................................................... 42 (i) Overall rating system structure.............................................................................................42 (ii) Rating grade structure.......................................................................................................... 43 C. COMPLETENESS AND INTEGRITY OF RATING ASSIGNMENTS ............................................................ 43 (i) Introduction........................................................................................................................... 43 (ii) Coverage of ratings .............................................................................................................. 43 (iii) Independent assignment or review ...................................................................................... 44 D. OVERSIGHT OVER THE RATING SYSTEM AND PROCESSES............................................................... 44 (i) Introduction........................................................................................................................... 44 E. CRITERIA AND ORIENTATION OF RATING SYSTEM ........................................................................... 45 (i) Introduction........................................................................................................................... 45 (ii) Assessment horizon ............................................................................................................. 45 F. MINIMUM REQUIREMENTS FOR ESTIMATION OF PD ........................................................................ 46 G. DATA COLLECTION AND IT SYSTEMS............................................................................................. 48 H. USE OF INTERNAL RATINGS .........................................................................................................