691:
are representative of its exposures, and there is no distortion in the calculation of regulatory capital due to the use of these models. Banks must also have in place a system governing the use of these models and whether they are fit for purpose for ongoing use; such a system must consider the stability of the model as well as its ability to predict default accurately.
826:
For retail exposures, the estimates should be based on minimum five years of data unless the bank can demonstrate that recent data is more informative than longer-period data in the sense that the reliance on only the recent data yields a better predictor of the estimates than the longer-period data
707:
Banks are also required to regularly stress test their rating systems considering economic downturn scenarios, market risk based events or liquidity conditions that may increase the level of capital held by the bank. These stress tests should not only consider the relevant internal data of the bank,
682:
A rating system typically assigns a borrower to a particular grade based on their probability of default. To avoid excessive concentration of borrowers in one particular grade, a bank must have a minimum of seven borrower grades for non-defaulted exposures and one for those that default. For retail
910:
A bank is required to compare the total expected losses with the total eligible provisions. If the expected loss amount is less than the provisions, the supervisor must consider if this is a true picture of reality, and, if so, then include the difference in Tier II capital. The expected losses for
690:
Credit scoring models are allowed to play a role in the estimation of the risk parameters as long as sufficient human judgment not captured by the model is taken into account to assign the final rating to a borrower. The bank must also satisfy the supervisor that the data used to build these models
686:
Rating systems must be clear and well documented. They must enable a third party, like internal audit or independent reviewer, to replicate the assignment of ratings and their appropriateness. All relevant up to date information must be used in the assignment of ratings. A bank must be conservative
548:
Direct ownership interests in the assets and income of a financial institution, or indirect interests through for example derivatives come under this category. For an exposure to qualify under this category, the return of the funds invested on the equities can be only realized through their sale or
716:
The rating systems should be approved by the Bank's board of directors and they should be familiar with the management reports created as part of the rating systems. Senior management should regularly review the rating system and identify areas needing improvement. Reporting is required to include
699:
The requirements state that for corporate, sovereign or bank exposures all borrowers and guarantors must be assigned a rating as part of the loan approval process. The process by which a rating is assigned and the actual ratings assigned must be reviewed periodically by a body independent of those
664:
Rating system refers to the entire mathematical and technological infrastructure a bank has put in place to quantify and assign the risk parameters. Banks are allowed to use multiple ratings systems for different exposures, but the methodology of assigning an exposure to a particular rating system
745:
Banks must satisfy the 'use test', which means that the ratings must be used internally in the risk management practices of the bank. A rating system solely devised for calculating regulatory capital is not acceptable. While banks are encouraged to improve their rating systems over time, they are
655:
To adopt the IRB approach, a bank must demonstrate ongoing compliance with the minimum requirements. If a bank does not satisfy the minimum requirements at any point of time, they must submit to the supervisor a plan outlining how they intend to return to compliance along with definite timelines.
865:
The capital charge is equivalent to the potential loss on the institution’s equity portfolio arising from an assumed instantaneous shock equivalent to the 99th percentile, one-tailed confidence interval of the difference between quarterly returns and an appropriate risk-free rate computed over a
791:
Loss, when estimating LGD, is economic loss and not accounting loss. This means that all material direct and indirect costs, as well as recoveries, must be discounted back to the point of default. The bank must clearly demonstrate the choice of the discount rate to the supervisor.
703:
All data relevant to assignment of ratings must be collected and maintained by the bank. The data collected is not only beneficial for improving the credit risk management process of the bank on an ongoing basis, but also required for necessary supervisory reporting.
503:
Loans made to banks or securities firms subject to regulatory capital requirements come under this category. Certain domestic PSEs or MDBs that do not meet the criteria for a 0% risk weight under the standardized approach also fall in this category.
436:
These corporate and retail classes are further divided into five and three sub-classes, respectively. In addition, both these classes have a separate treatment for purchased receivables, which might apply subjectivity to certain conditions.
524:
are some of the common retail lending products treated as part of this category in the IRB approach. Subject to a maximum of 1 million euros, exposures to small businesses managed as retail exposures also fall under this category.
528:
Retail exposures are usually not managed by the bank on an individual basis for risk rating purposes, but as groups of exposures with similar risk characteristics. The sub-classes of exposures falling into this category are -
400:
Estimate the risk parameters—probability of default (PD), loss given default (LGD), exposure at default (EAD), maturity (M)—that are inputs to risk-weight functions designed for each asset class to arrive at the total
621:
To adopt the IRB approach and its continued use, a bank must satisfy certain minimum requirements that it can demonstrate to the national supervisor. They are described in the following twelve sub-sections.
844:
Banks using the foundation approach use supervisory estimates of EADpreCCF and LGD. However, they must meet the minimum requirements of the standardized approach for recognition of eligible collateral.
468:- financing the reserves, receivables or inventories of exchange-traded commodities where the exposure is paid back based on the sale of the commodity rather than by the borrower from independent funds
359:. Only banks meeting certain minimum conditions, disclosure requirements and approval from their national supervisor are allowed to use this approach in estimating capital for various exposures.
474:
High-volatility commercial real estate - financing commercial real estate, which demonstrate a much higher volatility of loss rates as compared to other forms of specialized lending
613:
For equity exposures, calculation of risk-weighted assets not held in the trading book can be calculated using two different ways: a PD/LGD approach or a market-based approach.
448:
An exposure to a corporation, partnership or proprietorship falls under this category. Some special guidelines may apply if the corporation is small or medium-sized entity (
737:
An internal audit function, or equally independent function, must review the rating system at least once a year and the findings from such a review must be documented.
187:
483:
This generally refers to a loan made to a particular country. Under the Basel II guidelines, this class also includes the central banks of various countries, certain
799:
PD estimates may be derived based on one or more of the following techniques - internal default experience, mapping to external data, statistical default models.
853:
Leases other than those that expose the bank to residual value risk are accorded the same treatment as exposures collateralised by the same type of collateral.
823:
For corporate, sovereign or bank exposures, LGD and EAD estimates should be based on a full economic cycle and must not be shorter than a period of seven years.
939:
536:
Qualifying revolving exposure (QREs) - unsecured revolving exposures where the undrawn portion of the exposure is unconditionally cancellable by the bank
385:
Incentive compatibility - Banks must adopt better risk management techniques to control the credit risk in their portfolio to minimize regulatory capital
1012:
Basel II: International
Convergence of Capital Measurement and Capital Standards: a Revised Framework, Comprehensive Version (BCBS) (June 2006 Revision)
814:
For exposures already in default, LGD should be estimated as the best estimate of expected loss on the asset considering the current economic climate.
462:
Object
Finance - financing physical assets based upon the projected cash flows obtained primarily through the rental or lease of the particular assets
363:
330:
70:
248:
471:
Income-producing real estate - financing real estate that is usually rented or leased out by the debtor to generate cash flow to repay the exposure
465:
375:
214:
65:
30:
374:
The IRB approach relies on a bank's own assessment of its counterparties and exposures to calculate capital requirements for credit risk. The
382:
Risk sensitivity - Capital requirements based on internal estimates are more sensitive to the credit risk in the bank's portfolio of assets
886:
The models should be integrated into the risk management process; including setting hurdle rates and evaluating risk-adjusted performance
378:
explained the rationale for adopting this approach in a consultative paper issued in 2001. Such an approach has two primary objectives -
593:
In this approach, banks calculate their own PD parameter while the other risk parameters are provided by the bank's national supervisor
492:
209:
160:
787:
For retail exposures, a borrower defaulting on a particular exposure need not result in all exposures to the borrower being in default
665:
must be logical and documented; banks are not allowed to use a particular rating system to minimize regulatory capital requirements.
746:
required to demonstrate the use of risk parameters for risk management for at least three years prior to obtaining qualification.
781:
Borrower is 90 days past due on payment - for overdrafts, a breach on provided credit limit results in it being 'past due'
758:
Except for retail exposures, PD for a particular grade must be a long-run average of one year default rates for that grade
488:
323:
306:
253:
880:
The Accord does not require the use of a particular kind of model but requires that all risks be embedded in the process.
1041:
484:
449:
221:
883:
Stress testing taking into account various assumptions on volatility and hypothetical scenarios should be conducted
656:
Supervisors may take appropriate action or require the banks to hold additional capital in case of non-compliance.
874:
Estimated losses should be based on sound statistical judgment and should be stable under adverse market movements
943:
575:
Minimum requirements - Core minimum standards that a bank must satisfy to use the internal ratings-based approach
770:
A layer of conservatism should be added to the parameter estimates to control for errors during their estimation
734:
Banks must have independent functions responsible for development and ongoing monitoring of the rating systems.
565:
Risk parameters - Probability of default (PD), Exposure at default (EAD), Loss Given
Default (LGD), Maturity (M)
316:
243:
197:
60:
55:
902:
of the Basel framework. Failure to meet these requirements makes the bank ineligible to use the IRB approach.
761:
For those bankings using the advanced approach, a long run default-weighted average EAD must also be estimated
877:
Models should be adjusted to demonstrate that it provides a conservative estimate of long-run loss experience
133:
836:
Banks must have well-defined processes to estimate the accuracy and consistency of their rating systems.
927:
607:
In this approach, banks calculate their own risk parameters subject to meeting some minimum guidelines.
347:
guidelines, banks are allowed to use their own estimated risk parameters for the purpose of calculating
817:
For closed-end exposures, EAD must not be lower than the current outstanding balance owed to the bank.
1036:
911:
equity exposures under the PD/LGD approach is deducted 50% from Tier I and 50% from Tier II capital.
679:
For retail exposures, delinquent exposures should be identified separately from those that are not.
558:
402:
182:
128:
675:
Transaction specific factors like the nature of the product, terms of repayment, collateral, etc.
408:
The regulatory capital for credit risk is then calculated as 8% of the total RWA under Basel II.
362:
Reforms to the internal ratings-based approach to credit risk are due to be introduced under the
348:
767:
The estimates must be based on sound historical and empirical evidence and not purely judgmental
644:
The risk parameters must also be consistent with their use in making risk management decisions.
764:
The internal estimates must take into account all relevant internal and external data available
730:
a comparison of the actual default rates against the expected as predicted by the rating system
1031:
899:
452:). As noted above, there are five sub-classes of specialized lending under this asset class -
459:- financing industrial projects based upon the projected cash flows of the particular project
683:
exposures, banks should be able to quantify the risk parameters for each pool of exposures.
271:
238:
1016:
889:
The models must be regularly monitored by an independent team and all assumptions verified
811:
LGD estimates should be based on historical recoveries as well as any existing collateral.
456:
112:
99:
94:
974:
687:
in its estimates if there is a lack of data to accurately quantify the risk parameters.
588:
276:
170:
148:
143:
1025:
708:
but also macro-economic factors that might affect the accuracy of the rating system.
521:
35:
985:
861:
The capital charge for equity exposures is defined in the Basel Accord as follows -
602:
175:
103:
572:
regulatory framework, which maps the risk parameters above to risk-weighted assets
513:
356:
297:
204:
155:
802:
For retail exposures, the primary driver of PD estimates must be internal data.
700:
making loan approval decisions. Ratings must be reviewed at least once a year.
940:"Committee of European Banking Supervisors:Guidelines on AMA and IRB approach"
820:
For revolving exposures, EAD should take into account any undrawn commitments.
281:
672:
Borrower characteristics indicating the propensity of the borrower to default
517:
416:
Each banking exposure is categorized into one of these broad asset classes:
138:
50:
569:
394:
344:
45:
610:
However, the foundation approach is not available for Retail exposures.
393:
Categorize their exposures into various asset classes as defined by the
996:
963:
90:
40:
1011:
630:
The minimum requirements state that estimates of risk parameters must
795:
Important considerations in quantifying risk parameters include:
579:
The accord provides two broad approaches that a bank can follow:
108:
898:
Banks must meet the disclosure requirements as mandated by the
440:
The following paragraphs describe the asset classes in detail.
808:
LGD estimates should be based on economic downturn conditions.
231:
226:
491:(MDBs) that meet the criteria for a 0% risk weight under the
805:
Seasoning effects should be considered for retail exposures.
778:
Borrower is unlikely to pay its credit obligations in full
568:
Risk-weight functions - Functions provided as part of the
906:
Treatment of expected losses and recognition of provision
668:
A rating system must be designed based on two dimensions
561:
for all banking exposures, there are three main elements
389:
To use this approach, a bank must take two major steps:
975:
FSA Staff Paper:Qualifying
Revolving Retail Exposures
647:
The minimum requirements apply to all asset classes.
640:
Be accurate and consistent in the estimation of risk
512:
Loans made to individuals fall under this category.
857:
Calculation of capital charges for equity exposures
784:Borrower has been placed in bankruptcy protection
634:Reflect borrower and transaction characteristics
549:by liquidation of the issuer of these equities.
637:Provide for meaningful differentiation of risk
324:
8:
870:Further requirements are summarized below -
22:International regulatory standards for banks
331:
317:
15:
364:Basel III: Finalising post-crisis reforms
964:BCBS:The Internal Ratings-Based Approach
920:
849:Requirements for recognition of leasing
727:risk parameter estimates for each grade
289:
263:
120:
82:
18:
376:Basel Committee on Banking Supervision
31:Basel Committee on Banking Supervision
353:internal ratings-based (IRB) approach
7:
724:migrations across different grades
712:Corporate governance and oversight
553:Foundation and advanced approaches
14:
840:Supervisory LGD and EAD estimates
928:IRB Approach:bis2information.org
832:Validation of internal estimates
485:public sector enterprises (PSEs)
489:multilateral development banks
1:
307:Business and Economics Portal
355:to capital requirements for
264:Pillar 2: Supervisory review
121:Pillar 1: Regulatory capital
412:Categorization of exposures
290:Pillar 3: Market disclosure
1058:
600:
586:
403:risk weighted assets (RWA)
1017:FSA Handbook:IRB Approach
866:long-term sample period.
695:Rating system operations
894:Disclosure requirements
741:Use of internal ratings
351:. This is known as the
868:
774:Definition of default
863:
754:Overall requirements
721:risk profile by grade
522:residential mortgages
493:standardized approach
660:Rating system design
617:Minimum requirements
559:capital requirements
533:Residential mortgage
1042:Capital requirement
750:Risk quantification
583:Foundation approach
466:Commodities Finance
129:Capital requirement
349:regulatory capital
986:OECD:IRB Approach
597:Advanced approach
341:
340:
23:
1049:
999:
997:The IRB Use Test
994:
988:
983:
977:
972:
966:
961:
955:
954:
952:
951:
942:. Archived from
936:
930:
925:
333:
326:
319:
272:Economic capital
239:Operational risk
21:
19:Basel Framework
16:
1057:
1056:
1052:
1051:
1050:
1048:
1047:
1046:
1022:
1021:
1008:
1003:
1002:
995:
991:
984:
980:
973:
969:
962:
958:
949:
947:
938:
937:
933:
926:
922:
917:
908:
896:
859:
851:
842:
834:
752:
743:
714:
697:
662:
653:
628:
619:
605:
591:
555:
546:
510:
501:
481:
457:Project Finance
446:
414:
372:
337:
113:Risk management
100:Monetary policy
20:
12:
11:
5:
1055:
1053:
1045:
1044:
1039:
1034:
1024:
1023:
1020:
1019:
1014:
1007:
1006:External links
1004:
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661:
658:
652:
649:
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601:Main article:
599:
598:
589:Foundation IRB
587:Main article:
585:
584:
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576:
573:
566:
554:
551:
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541:
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279:
277:Liquidity risk
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139:Leverage ratio
136:
123:
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118:
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116:
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106:
97:
85:
84:
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48:
43:
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25:
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6:
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3:
2:
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1043:
1040:
1038:
1035:
1033:
1030:
1029:
1027:
1018:
1015:
1013:
1010:
1009:
1005:
998:
993:
990:
987:
982:
979:
976:
971:
968:
965:
960:
957:
946:on 2012-01-23
945:
941:
935:
932:
929:
924:
921:
914:
912:
905:
903:
901:
893:
888:
885:
882:
879:
876:
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871:
867:
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856:
854:
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839:
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831:
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819:
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763:
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749:
747:
740:
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723:
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711:
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674:
671:
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669:
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623:
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596:
595:
594:
590:
582:
581:
580:
574:
571:
567:
564:
563:
562:
560:
557:To calculate
552:
550:
543:
538:
535:
532:
531:
530:
526:
523:
519:
515:
507:
505:
498:
496:
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367:
365:
360:
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346:
334:
329:
327:
322:
320:
315:
314:
312:
311:
308:
305:
304:
299:
296:
295:
294:
293:
288:
283:
280:
278:
275:
273:
270:
269:
268:
267:
262:
255:
252:
250:
247:
245:
242:
241:
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237:
233:
230:
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208:
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203:
199:
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185:
184:
181:
177:
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172:
169:
168:
167:
164:
162:
159:
158:
157:
154:
150:
147:
145:
142:
140:
137:
135:
134:Capital ratio
132:
131:
130:
127:
126:
125:
124:
119:
114:
110:
107:
105:
101:
98:
96:
92:
89:
88:
87:
86:
81:
72:
69:
67:
64:
62:
59:
57:
54:
53:
52:
49:
47:
44:
42:
39:
38:
37:
36:Basel Accords
34:
32:
29:
28:
27:
26:
17:
992:
981:
970:
959:
948:. Retrieved
944:the original
934:
923:
909:
900:third pillar
897:
869:
864:
860:
852:
843:
835:
794:
790:
773:
753:
744:
736:
733:
715:
706:
702:
698:
689:
685:
681:
678:
667:
663:
654:
646:
643:
629:
620:
612:
609:
606:
603:Advanced IRB
592:
578:
556:
547:
539:Other retail
527:
514:Credit cards
511:
502:
482:
447:
439:
435:
415:
407:
388:
373:
361:
352:
342:
249:Standardized
210:Standardized
165:
104:Central bank
1037:Credit risk
626:Composition
366:standards.
357:credit risk
205:Market risk
156:Credit risk
1026:Categories
950:2011-09-14
915:References
651:Compliance
518:overdrafts
343:Under the
298:Disclosure
282:Legal risk
95:Regulation
83:Background
479:Sovereign
444:Corporate
423:Sovereign
420:Corporate
51:Basel III
1032:Basel II
570:Basel II
487:and the
395:Basel II
370:Overview
345:Basel II
46:Basel II
222:CVA vol
91:Banking
71:Endgame
41:Basel I
827:would.
544:Equity
508:Retail
432:Equity
429:Retail
397:accord
232:SA-CVA
227:BA-CVA
188:SA-CCR
149:Tier 2
144:Tier 1
244:Basic
176:A-IRB
171:F-IRB
161:SA-CR
499:Bank
426:Bank
109:Risk
66:FRTB
61:NSFR
520:or
450:SME
254:AMA
215:IMA
198:CCF
192:IMM
183:EAD
166:IRB
56:LCR
1028::
516:,
495:.
111:/
102:/
93:/
953:.
332:e
325:t
318:v
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