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Basel ii Accord
Section 211 to 230 |
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III.
Credit Risk ─ The Internal Ratings-Based
Approach
A.
Overview
211.
This section of the Framework describes the IRB
approach to credit risk. Subject
to
certain
minimum conditions and disclosure requirements,
banks that have received
supervisory
approval to use the IRB approach may rely on
their own internal estimates of risk components
in determining the capital requirement for a
given exposure.
The
risk components include measures of the
probability of default (PD), loss given default
(LGD), the exposure at default (EAD), and
effective maturity (M). In some cases, banks may
be required to use a supervisory value as
opposed to an internal estimate for one or more
of the risk components.
212.
The IRB approach is based on measures of
unexpected losses (UL) and
expected
losses
(EL). The risk-weight functions produce capital
requirements for the UL
portion.
Expected
losses are treated separately, as outlined in
paragraph 43 and Section III.G.
213.
In this section, the asset classes are defined
first. Adoption of the IRB
approach
across
all asset classes is also discussed early in
this section, as are
transitional
arrangements.
The
risk components, each of which is defined later
in this section, serve as inputs to the
risk-weight functions that have been developed
for separate asset classes. For example, there
is a risk-weight function for corporate
exposures and another one for qualifying
revolving retail exposures. The treatment of
each asset class begins with a presentation of
the relevant risk-weight function(s) followed by
the risk components and other relevant factors,
such as the treatment of credit risk mitigants.
The
legal certainty standards for recognising CRM as
set out in Section II.D apply for both the
foundation and advanced IRB approaches. The
minimum requirements that banks must satisfy to
use the IRB approach are presented at the end of
this section starting at Section III.H,
paragraph 387.
B.
Mechanics of the IRB
approach
214.
In Section III.B.1, the risk components (e.g. PD
and LGD) and asset classes
(e.g.
corporate
exposures and retail exposures) of the IRB
approach are defined. Section 2
provides
a description of the risk components to be used
by banks by asset class. Sections
3
and
4 discuss a bank’s adoption of the IRB approach
and transitional arrangements,
respectively.
In cases where an IRB treatment is not
specified, the risk weight for those
other
exposures
is 100%, except when a 0% risk weight applies
under the standardised
approach,
and
the resulting risk-weighted assets are assumed
to represent UL only.
1. Categorisation of
exposures
215.
Under the IRB approach, banks must categorise
banking-book exposures into
broad
classes
of assets with different underlying risk
characteristics, subject to the definitions
set
out
below. The classes of assets are
(a)
corporate,
(b)
sovereign,
(c)
bank,
(d)
retail, and
(e)
equity.
Within
the corporate asset class, five sub-classes of
specialised lending are
separately
identified. Within the retail asset class, three
sub-classes are separately
identified.
Within
the corporate and retail asset classes, a
distinct treatment for purchased
receivables
may
also apply provided certain conditions are
met.
216.
The classification of exposures in this way is
broadly consistent with
established
bank
practice. However, some banks may use different
definitions in their internal
risk
management
and measurement systems. While it is not the
intention of the Committee to
require
banks to change the way in which they manage
their business and risks, banks
are
required
to apply the appropriate treatment to each
exposure for the purposes of
deriving
their
minimum capital requirement. Banks must
demonstrate to supervisors that
their
methodology
for assigning exposures to different classes is
appropriate and consistent over
time.
217.
For a discussion of the IRB treatment of
securitisation exposures, see Section
IV.
(i)
Definition of corporate
exposures
218.
In general, a corporate exposure is defined as a
debt obligation of a
corporation,
partnership,
or proprietorship. Banks are permitted to
distinguish separately exposures
to
small-
and medium-sized entities (SME), as defined in
paragraph 273.
219.
Within the corporate asset class, five
sub-classes of specialised lending (SL)
are
identified.
Such lending possesses all the following
characteristics, either in legal form
or
economic
substance:
•
The
exposure is typically to an entity (often a
special purpose entity (SPE))
which
was
created specifically to finance and/or operate
physical assets;
•
The
borrowing entity has little or no other material
assets or activities, and
therefore
little
or no independent capacity to repay the
obligation, apart from the income that
it
receives
from the asset(s) being
financed;
•
The
terms of the obligation give the lender a
substantial degree of control over
the
asset(s)
and the income that it generates;
and
•
As a
result of the preceding factors, the primary
source of repayment of the
obligation
is the income generated by the asset(s), rather
than the independent
capacity
of a broader commercial
enterprise.
220.
The five sub-classes of specialised lending are
project finance, object
finance,
commodities
finance, income-producing real estate, and
high-volatility commercial real
estate.
Each of these sub-classes is defined
below.
Project
finance
221.
Project finance (PF) is a method of funding in
which the lender looks primarily to
the
revenues
generated by a single project, both as the
source of repayment and as security
for
the
exposure. This type of financing is usually for
large, complex and expensive
installations
that
might include, for example, power plants,
chemical processing plants,
mines,
transportation
infrastructure, environment, and
telecommunications infrastructure.
Project
finance may take the form of financing of the
construction of a new capital installation, or
refinancing of an existing installation, with or
without improvements.
222.
In such transactions, the lender is usually paid
solely or almost exclusively out of
the
money
generated by the contracts for the facility’s
output, such as the electricity sold by
a
power
plant. The borrower is usually an SPE that is
not permitted to perform any
function
other
than developing, owning, and operating the
installation.
The
consequence is that repayment depends primarily
on the project’s cash flow and on the collateral
value of the project’s assets. In contrast, if
repayment of the exposure depends primarily on a
well established, diversified, credit-worthy,
contractually obligated end user for repayment,
it is considered a secured exposure to that
end-user.
Object
finance
223.
Object finance (OF) refers to a method of
funding the acquisition of physical
assets
(e.g.
ships, aircraft, satellites, railcars, and
fleets) where the repayment of the exposure
is
dependent
on the cash flows generated by the specific
assets that have been financed
and
pledged
or assigned to the lender.
A
primary source of these cash flows might be
rental or lease contracts with one or several
third parties. In contrast, if the exposure is
to a borrower whose financial condition and
debt-servicing capacity enables it to repay the
debt without undue reliance on the specifically
pledged assets, the exposure should be treated
as a collateralised corporate
exposure.
Commodities
finance
224.
Commodities finance (CF) refers to structured
short-term lending to finance
reserves,
inventories, or receivables of exchange-traded
commodities (e.g. crude oil,
metals,
or
crops), where the exposure will be repaid from
the proceeds of the sale of the
commodity
and
the borrower has no independent capacity to
repay the exposure.
This
is the case when the borrower has no other
activities and no other material assets on its
balance sheet. The structured nature of the
financing is designed to compensate for the weak
credit quality of the borrower. The exposure’s
rating reflects its self-liquidating nature and
the lender’s skill in structuring the
transaction rather than the credit quality of
the borrower.
225.
The Committee believes that such lending can be
distinguished from exposures
financing
the reserves, inventories, or receivables of
other more diversified
corporate
borrowers.
Banks are able to rate the credit quality of the
latter type of borrowers based
on
their
broader ongoing operations. In such cases, the
value of the commodity serves as a
risk
mitigant
rather than as the primary source of
repayment.
Income-producing
real estate
226.
Income-producing real estate (IPRE) refers to a
method of providing funding to
real
estate
(such as, office buildings to let, retail space,
multifamily residential buildings, industrial or
warehouse space, and hotels) where the prospects
for repayment and recovery on the exposure
depend primarily on the cash flows generated by
the asset. The primary source of these cash
flows would generally be lease or rental
payments or the sale of the
asset.
The
borrower may be, but is not required to be, an
SPE, an operating company focused
on
real
estate construction or holdings, or an operating
company with sources of revenue
other
than
real estate. The distinguishing characteristic
of IPRE versus other corporate
exposures
that
are collateralised by real estate is the strong
positive correlation between the
prospects
for
repayment of the exposure and the prospects for
recovery in the event of default,
with
both
depending primarily on the cash flows generated
by a property.
High-volatility
commercial real estate
227.
High-volatility commercial real estate (HVCRE)
lending is the financing of
commercial
real estate that exhibits higher loss rate
volatility (i.e. higher asset
correlation)
compared
to other types of SL. HVCRE
includes:
•
Commercial real
estate exposures secured by properties of types
that are
categorised
by the national supervisor as sharing higher
volatilities in portfolio
default
rates;
•
Loans
financing any of the land acquisition,
development and construction
(ADC)
phases
for properties of those types in such
jurisdictions; and
•
Loans
financing ADC of any other properties where the
source of repayment at
origination
of the exposure is either the future uncertain
sale of the property or cash
flows
whose source of repayment is substantially
uncertain (e.g. the property
has
not
yet been leased to the occupancy rate prevailing
in that geographic market for
that
type of commercial real estate), unless the
borrower has substantial equity
at
risk.
Commercial
ADC loans exempted from treatment as HVCRE loans
on the
basis
of certainty of repayment of borrower equity
are, however, ineligible for
the
additional
reductions for SL exposures described in
paragraph 277.
228.
Where supervisors categorise certain types of
commercial real estate exposures
as
HVCRE
in their jurisdictions, they are required to
make public such determinations.
Other
supervisors
need to ensure that such treatment is then
applied equally to banks under
their
supervision
when making such HVCRE loans in that
jurisdiction.
(ii)
Definition of sovereign
exposures
229.
This asset class covers all exposures to
counterparties treated as sovereigns
under
the
standardised approach. This includes sovereigns
(and their central banks), certain
PSEs
identified
as sovereigns in the standardised approach, MDBs
that meet the criteria for a 0%
risk
weight under the standardised approach, and the
entities referred to in paragraph
56.
(iii)
Definition of bank
exposures
230.
This asset class covers exposures to banks and
those securities firms outlined
in
paragraph
65. Bank exposures also include claims on
domestic PSEs that are treated
like
claims
on banks under the standardised approach, and
MDBs that do not meet the
criteria
for
a 0% risk weight under the standardised
approach.
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