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2.
Foundation and advanced
approaches
244.
For each of the asset classes covered under the
IRB framework, there are three
key
elements:
•
Risk
components ─ estimates of risk parameters
provided by banks some of
which
are
supervisory estimates.
•
Risk-weight functions
─ the means by which risk components are
transformed into
risk-weighted
assets and therefore capital
requirements.
•
Minimum requirements
─ the minimum standards that must be met in
order for a
bank
to use the IRB approach for a given asset
class.
245.
For many of the asset classes, the Committee has
made available two broad
approaches:
a foundation and an advanced. Under the
foundation approach, as a
general
rule,
banks provide their own estimates of PD and rely
on supervisory estimates for other risk
components. Under the advanced approach, banks
provide more of their own estimates of PD, LGD
and EAD, and their own calculation of M, subject
to meeting minimum standards.
For
both the foundation and advanced approaches,
banks must always use the
risk-weight
functions
provided in this Framework for the purpose of
deriving capital requirements.
The
full
suite of approaches is described
below.
(i)
Corporate, sovereign, and bank
exposures
246.
Under the foundation approach, banks must
provide their own estimates of
PD
associated
with each of their borrower grades, but must use
supervisory estimates for the
other relevant risk
components. The other risk components are LGD,
EAD and M.
(66)
(66) As noted in paragraph 318,
some supervisors may require banks using the
foundation approach to calculate M using the
definition provided in paragraphs 320 to
324.
247. Under the
advanced approach, banks must calculate the
effective maturity (M)
(67 )and
provide
their own estimates of PD, LGD and
EAD.
67 At the discretion of the
national supervisor, certain domestic exposures
may be exempt from the calculation of M (see
paragraph 319).
248.
There is an exception to this general rule for
the five sub-classes of assets
identified
as
SL.
The
SL categories: PF, OF, CF, IPRE, and
HVCRE
249.
Banks that do not meet the requirements for the
estimation of PD under the
corporate
foundation approach for their SL assets are
required to map their internal
risk
grades
to five supervisory categories, each of which is
associated with a specific risk
weight.
This
version is termed the ‘supervisory slotting
criteria approach’.
250.
Banks that meet the requirements for the
estimation of PD are able to use
the
foundation
approach to corporate exposures to derive risk
weights for all classes of SL
exposures
except HVCRE. At national discretion, banks
meeting the requirements for
HVCRE
exposure are able to use a foundation approach
that is similar in all respects to
the
corporate
approach, with the exception of a separate
risk-weight function as described
in
paragraph
283.
251.
Banks that meet the requirements for the
estimation of PD, LGD and EAD are
able
to
use the advanced approach to corporate exposures
to derive risk weights for all classes
of
SL
exposures except HVCRE. At national discretion,
banks meeting these requirements
for
HVCRE
exposure are able to use an advanced approach
that is similar in all respects to
the
corporate
approach, with the exception of a separate
risk-weight function as described
in
paragraph
283.
(ii)
Retail exposures
252.
For retail exposures, banks must provide their
own estimates of PD, LGD and
EAD.
There
is no distinction between a foundation and
advanced approach for this asset
class.
(iii)
Equity exposures
253.
There are two broad approaches to calculate
risk-weighted assets for equity
exposures
not held in the trading book: a market-based
approach and a PD/LGD approach.
These
are set out in full in paragraphs 340 to
361.
254.
The PD/LGD approach to equity exposures remains
available for banks that adopt
the
advanced approach for other exposure
types.
(iv)
Eligible purchased
receivables
255.
The treatment potentially straddles two asset
classes. For eligible corporate
receivables,
both a foundation and advanced approach are
available subject to certain
operational
requirements being met. For eligible retail
receivables, as with the retail
asset
class,
there is no distinction between a foundation and
advanced approach.
3.
Adoption of the IRB approach across asset
classes
256.
Once a bank adopts an IRB approach for part of
its holdings, it is expected to
extend
it
across the entire banking group. The Committee
recognises however, that, for
many
banks,
it may not be practicable for various reasons to
implement the IRB approach
across
all
material asset classes and business units at the
same time.
Furthermore,
once on IRB, data limitations may mean that
banks can meet the standards for the use of own
estimates of LGD and EAD for some but not all of
their asset classes/business units at the same
time.
257.
As such, supervisors may allow banks to adopt a
phased rollout of the IRB
approach
across
the banking group. The phased rollout
includes
(i)
adoption of IRB across asset classes within the
same business unit (or in the case of retail
exposures across individual sub-classes);
(ii)
adoption of IRB across business units in the
same banking group; and
(iii)
move from the foundation approach to the
advanced approach for certain risk
components.
However,
when a bank adopts an IRB approach for an asset
class within a particular
business
unit (or in the case of retail exposures for an
individual sub-class), it must apply
the
IRB
approach to all exposures within that asset
class (or sub-class) in that
unit.
258.
A bank must produce an implementation plan,
specifying to what extent and when
it
intends
to roll out IRB approaches across significant
asset classes (or sub-classes in
the
case
of retail) and business units over time. The
plan should be exacting, yet realistic,
and
must
be agreed with the supervisor.
It
should be driven by the practicality and
feasibility of moving to the more advanced
approaches, and not motivated by a desire to
adopt a Pillar 1 approach that minimises its
capital charge. During the roll-out period,
supervisors will ensure that no capital relief
is granted for intra-group transactions which
are designed to reduce a banking group’s
aggregate capital charge by transferring credit
risk among entities on the standardised
approach, foundation and advanced IRB
approaches. This includes, but is not limited
to, asset sales or cross
guarantees.
259.
Some exposures in non-significant business units
as well as asset classes (or
subclasses
in
the case of retail) that are immaterial in terms
of size and perceived risk
profile
may
be exempt from the requirements in the previous
two paragraphs, subject to supervisory approval.
Capital
requirements for such operations will be
determined according to the
standardised
approach, with the national supervisor
determining whether a bank should hold more
capital under Pillar 2 for such
positions.
260.
Notwithstanding the above, once a bank has
adopted the IRB approach for all
or
part
of any of the corporate, bank, sovereign, or
retail asset classes, it will be required
to
adopt
the IRB approach for its equity exposures at the
same time, subject to
materiality.
Supervisors
may require a bank to employ one of the IRB
equity approaches if its equity
exposures
are a significant part of the bank’s business,
even though the bank may not
employ
an IRB approach in other business lines.
Further, once a bank has adopted
the
general
IRB approach for corporate exposures, it will be
required to adopt the IRB
approach
for
the SL sub-classes within the corporate exposure
class.
261.
Banks adopting an IRB approach are expected to
continue to employ an IRB
approach.
A voluntary return to the standardised or
foundation approach is permitted only
in
extraordinary
circumstances, such as divestiture of a large
fraction of the bank’s creditrelated business,
and must be approved by the
supervisor.
262.
Given the data limitations associated with SL
exposures, a bank may remain on
the
supervisory
slotting criteria approach for one or more of
the PF, OF, CF, IPRE or HVCRE
sub-classes,
and move to the foundation or advanced approach
for other sub-classes within
the
corporate asset class. However, a bank should
not move to the advanced approach
for
the
HVCRE sub-class without also doing so for
material IPRE exposures at the same
time.
4.
Transition
arrangements
(i)
Parallel calculation
263.
Banks adopting the foundation or advanced
approaches are required to
calculate
their
capital requirement using these approaches, as
well as the 1988 Accord for the
time
period
specified in paragraphs 45 to 49. Parallel
calculation for banks adopting
the
foundation
IRB approach to credit risk will start in the
year beginning year-end 2005.
Banks
moving directly from the 1988 Accord to the
advanced approaches to credit
and/or
operational
risk will be subject to parallel calculations or
impact studies for the year beginning year-end
2005 and to parallel calculations for the year
beginning year-end 2006.
(ii)
Corporate, sovereign, bank, and retail
exposures
264. The transition period starts on the date of
implementation of this Framework and will last
for 3 years from that date. During the
transition period, the following minimum
requirements can be relaxed, subject to
discretion of the national
supervisor:
•
For
corporate, sovereign, and bank exposures under
the foundation approach,
paragraph
463, the requirement that, regardless of the
data source, banks must use
at
least five years of data to estimate the PD;
and
•
For
retail exposures, paragraph 466, the requirement
that regardless of the data
source
banks must use at least five years of data to
estimate loss characteristics
(EAD,
and either expected loss (EL) or PD and
LGD).
•
For
corporate, sovereign, bank, and retail
exposures, paragraph 445,
the
requirement
that a bank must demonstrate it has been using a
rating system that
was
broadly in line with the minimum requirements
articulated in this document
for
at
least three years prior to
qualification.
•
The
applicable aforementioned transitional
arrangements also apply to the
PD/LGD
approach
to equity. There are no transitional
arrangements for the
market-based
approach
to equity.
265.
Under these transitional arrangements banks are
required to have a minimum of
two
years
of data at the implementation of this Framework.
This requirement will increase by one year for
each of three years of
transition.
266.
Owing to the potential for very long-run cycles
in house prices which short-term
data
may
not adequately capture, during this transition
period, LGDs for retail exposures
secured
by
residential properties cannot be set below 10%
for any sub-segment of exposures
to
which the formula in
paragraph 328 is applied.
(68) During the transition
period the Committee
will review the potential need for continuation
of this floor.
(iii)
Equity exposures
(68) The 10% LGD floor shall not
apply, however, to sub-segments that are subject
to/benefit from sovereign guarantees. Further,
the existence of the floor does not imply any
waiver of the requirements of LGD estimation as
laid out in the minimum requirements starting
with paragraph
468.
267.
For a maximum of ten years, supervisors may
exempt from the IRB treatment
particular equity
investments held at the time of the publication
of this Framework.
(69) The
exempted
position is measured as the number of shares as
of that date and any additional
arising
directly as a result of owning those holdings,
as long as they do not increase
the
proportional
share of ownership in a portfolio
company.
(69) This exemption does not apply
to investments in entities where some countries
will retain the existing risk weighting
treatment, as referred to in Part 1, see
footnote 9.
268.
If an acquisition increases the proportional
share of ownership in a specific
holding
(e.g.
due to a change of ownership initiated by the
investing company subsequent to
the
publication
of this Framework) the exceeding part of the
holding is not subject to the
exemption.
Nor will the exemption apply to holdings that
were originally subject to the
exemption,
but have been sold and then bought
back.
269.
Equity holdings covered by these transitional
provisions will be subject to the
capital
requirements
of the standardised
approach.
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