Revisions to the Standardised Approach for credit risk: Basel Committee issues consultative document

The Basel Committee on Banking Supervision has released today a consultative document on Revisions to the Standardised Approach for credit risk.

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

(1) reduced reliance on external credit ratings;

(2) enhanced granularity and risk sensitivity;

(3) 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;

(4) more comparability with the internal ratings-based (IRB) approach with respect to the definition and treatment of similar exposures; and

(5) better clarity on the application of the standards.

The Committee is considering replacing references to external ratings, as used in the current standardised 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 but which also reflect the local nature of some exposures - such as retail credit and mortgages - the Committee recognises that the proposals are still at an early stage of development. Thus, the Committee 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% 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: the framework would be amended by reducing the number of approaches, recalibrating supervisory haircuts and updating the corporate guarantor eligibility criteria.

The Committee has also published today a consultative paper Capital floors: the design of a framework based on standardised approaches, which sets out the proposed design of a capital floor framework based on standardised, non-internal modelled approaches.

The Committee welcomes comments on all aspects of this consultative document and the proposed standards text, particularly on the design of the framework. Comments on the proposals should be uploaded here by Friday 27 March 2015. All comments will be published on the website of the Bank for International Settlements unless a respondent specifically requests confidential treatment.