In December 2014, the Basel Committee published an initial proposal for a revised framework for a Standardised Approach for credit risk, or SA-CR for short. The first consultative document on the new SA-CR was very comprehensive and, in that form, would have resulted in a great deal of effort and cost for financial institutions in order to make the adjustments. This approach was largely based on the complete abandonment of the use of external ratings for calculating risk weights as well as on the introduction of new risk drivers, such as, for example, the leverage ratio for corporates, or the CET1 ratio for banks. The proposal attracted a lot of criticism in view of the enormous data requirements and the insignificant increase in risk sensitivity. After the first "Quantitative Impact Study" (QIS), the Committee decided to revise the requirements and, in December 2015, it published a second consultative document for the new SA-CR.
The new SA-CR - Present status
In the second consultative document for the revision of the SA-CR, the introduction of new risk drivers was abandoned and the use of external ratings for calculating risk weights was allowed once again.
In future, when calculating risk weights for the banks and corporates exposure classes, a distinction will be made between countries that allow the use of external ratings and those that do not allow this.
If external ratings may be used then these will now have to undergo an additional internal risk assessment (due diligence) in order to determine whether or not they are adequate. On the basis of this assessment, potentially, the risk weight could be increased but it could never be reduced. At SKS, we believe that integrating this due diligence into the existing reporting process will be one of the key challenges when implementing the new SA-CR.
Banks in countries that do not allow the use of external ratings will have to classify their counterparties into one of three grades (A-C) to which an appropriate risk-weight (50-150%) will be assigned.
Big adjustments will need to be made to positions secured by real estate
The most extensive adjustment requirement is expected in the exposure class of positions secured by real estate. Real estate was hitherto only classified into commercial and residential categories with permanently assigned risk-weights in each case. Now, additional distinctions will be made between income-producing real estate, non-income producing real estate as well as exposures related to land acquisition, development and construction (abbreviated to ADC). In future, the risk-weight will be largely based on the loan-to-value ratio. The mortgage and pfandbrief banks, in particular, will be severely impacted by these changes.
Adjustments in the retail portfolio area and in off-balance sheet positions
In the current SA-CR, a general risk-weight of 75% is applied to all retail positions. The new SA-CR divides retail exposures into two categories: regulatory retail and other retail. Regulatory retail exposures would be risk-weighted at 75% and other retail exposures at 100%.
For off-balance sheet items, in future, a 0% credit conversion factor (CCF) will no longer be applicable. For cancellable commitments for corporate financings, depending on the term of the loan, a CCF of 50%-75% can be expected. In future, a CCF of 10% will apply to the cancellable commitments in the retail portfolio.
SME supporting factor, currency risks and offsetting of collateral
It is likely that the revision of the SA-CR will lead to higher capital requirements. For example, in future, SMEs will no longer benefit from the usual SME supporting factor. A general FX add-on of 50% will be applied to corporate financings, retail exposures and positions secured by residential property in foreign currencies and through this the amount that has to be backed by capital will be further increased.
In contrast to what was originally planned, in future, it will still be possible to use external ratings (insofar as these are allowed in the country of registration) for the calculation of haircuts in the case of financial collateral. However, it will no longer be possible to use own estimates of haircuts or value-at-risk models. Besides the elimination of internal models, it will also no longer be possible to collateralise with nth-to-default credit swaps. In this case, too, a higher capital requirement to cover such commitments can be expected.
Implications of the new SA-CR
The planned changes to the standardised approach for credit risk will affect banks applying the SA as well as the IRB approach, as the new SA-CR is supposed to replace Principle I as a floor. With increased RWAs the banks will be forced to adjust their capital accordingly.
In the course of the Basel III QIS 2016, the Committee would like to collect and analyse data for the second consultative document.