Recognition
under the advanced
approach
306.
Banks using the advanced approach for estimating
LGDs may reflect the
riskmitigating
effect
of guarantees and credit derivatives through
either adjusting PD or LGD estimates. Whether
adjustments are done through PD or LGD, they
must be done in a consistent manner for a given
guarantee or credit derivative type.
In
doing so, banks must not include the effect of
double default in such adjustments. Thus, the
adjusted risk weight must not be less than that
of a comparable direct exposure to the
protection provider.
307.
A bank relying on own-estimates of LGD has the
option to adopt the treatment
outlined
above for banks under the foundation IRB
approach (paragraphs 302 to 305), or
to
make
an adjustment to its LGD estimate of the
exposure to reflect the presence of
the
guarantee
or credit derivative.
Under
this option, there are no limits to the range of
eligible guarantors although the set of minimum
requirements provided in paragraphs 483 and 484
concerning the type of guarantee must be
satisfied. For credit derivatives, the
requirements of paragraphs 488
and 489 must be satisfied.
(75)
(75) When credit derivatives do
not cover the restructuring of the underlying
obligation, the partial recognition set out in
paragraph 192
applies.
Operational
requirements for recognition of double
default
307
(i). A bank using an IRB approach has the option
of using the substitution approach
in
determining
the appropriate capital requirement for an
exposure. However, for
exposures
hedged
by one of the following instruments the double
default framework according to
paragraphs
284 (i) to 284 (iii) may be applied subject to
the additional operational
requirements
set out in paragraph 307 (ii).
A
bank may decide separately for each eligible
exposure to apply either the double default
framework or the substitution
approach.
(a)
Single-name, unfunded credit derivatives (e.g.
credit default swaps) or
singlename
guarantees.
(b)
First-to-default basket products — the double
default treatment will be applied
to
the
asset within the basket with the lowest
risk-weighted amount.
(c)
nth-to-default basket
products — the protection obtained is only
eligible for consideration under the double
default framework if eligible
(n–1)th default
protection has also been obtained or where (n–1)
of the assets within the basket have already
defaulted.
307
(ii). The double default framework is only
applicable where the following conditions
are
met.
(a)
The risk weight that is associated with the
exposure prior to the application of
the
framework
does not already factor in any aspect of the
credit protection.
(b) The entity
selling credit protection is a
bank (76), investment firm or
insurance
company
(but only those that are in the business of
providing credit protection,
including mono-lines,
re-insurers, and non-sovereign credit export
agencies (77)),
referred
to as a financial firm, that:
•
is
regulated in a manner broadly equivalent to that
in this Framework
(where
there is appropriate supervisory oversight and
transparency/
market
discipline), or externally rated as at least
investment grade by a
credit
rating agency deemed suitable for this purpose
by supervisors;
•
had
an internal rating with a PD equivalent to or
lower than that
associated
with an external A– rating at the time the
credit protection for
an
exposure was first provided or for any period of
time thereafter; and
•
has
an internal rating with a PD equivalent to or
lower than that
associated
with an external investment-grade
rating.
(c)
The underlying obligation is:
•
a
corporate exposure as defined in paragraphs 218
to 228 (excluding
specialised
lending exposures for which the supervisory
slotting criteria
approach
described in paragraphs 275 to 282 is being
used); or
•
a
claim on a PSE that is not a sovereign exposure
as defined in
paragraph
229; or
•
a
loan extended to a small business and classified
as a retail exposure
as
defined in paragraph 231.
(d)
The underlying obligor is not:
•
a
financial firm as defined in (b);
or
•
a
member of the same group as the protection
provider.
(e)
The credit protection meets the minimum
operational requirements for
such
instruments
as outlined in paragraphs 189 to
193.
(f)
In keeping with paragraph 190 for guarantees,
for any recognition of double
default
effects for both guarantees and credit
derivatives a bank must have
the
right
and expectation to receive payment from the
credit protection provider
without
having to take legal action in order to pursue
the counterparty for
payment.
To the extent possible, a bank should take steps
to satisfy itself that the
protection
provider is willing to pay promptly if a credit
event should occur.
(g)
The purchased credit protection absorbs all
credit losses incurred on the
hedged
portion
of an exposure that arise due to the credit
events outlined in the
contract.
(h)
If the payout structure provides for physical
settlement, then there must be
legal
certainty
with respect to the deliverability of a loan,
bond, or contingent liability.
If
a
bank intends to deliver an obligation other than
the underlying exposure, it
must
ensure
that the deliverable obligation is sufficiently
liquid so that the bank would
have
the ability to purchase it for delivery in
accordance with the contract.
(i)
The terms and conditions of credit protection
arrangements must be legally
confirmed
in writing by both the credit protection
provider and the bank.
(j)
In the case of protection against dilution risk,
the seller of purchased
receivables
must
not be a member of the same group as the
protection provider.
(k)
There is no excessive correlation between the
creditworthiness of a
protection
provider
and the obligor of the underlying exposure due
to their performance
being
dependent on common factors beyond the
systematic risk factor. The
bank
has
a process to detect such excessive correlation.
An example of a situation in
which
such excessive correlation would arise is when a
protection provider
guarantees
the debt of a supplier of goods or services and
the supplier derives a
high
proportion of its income or revenue from the
protection provider.
(76) This does not include PSEs
and MDBs, even though claims on these may be
treated as claims on banks according to
paragraph 230.
(77) By non-sovereign it is meant
that credit protection in question does not
benefit from any explicit sovereign
counter-guarantee.
(iii)
Exposure at default
(EAD)
308.
The following sections apply to both on and
off-balance sheet positions.
All
exposures
are measured gross of specific provisions or
partial write-offs. The EAD on
drawn
amounts
should not be less than the sum of (i) the
amount by which a bank’s
regulatory
capital
would be reduced if the exposure were
written-off fully, and (ii) any specific
provisions
and
partial write-offs.
When
the difference between the instrument’s EAD and
the sum of (i) and (ii) is positive, this amount
is termed a discount. The calculation of
risk-weighted assets is independent of any
discounts. Under the limited circumstances
described in paragraph
380,
discounts may be included in the measurement of
total eligible provisions for
purposes
of
the EL-provision calculation set out in Section
III.G.
Exposure
measurement for on-balance sheet
items
309.
On-balance sheet netting of loans and deposits
will be recognised subject to
the
same
conditions as under the standardised approach
(see paragraph 188). Where
currency
or
maturity mismatched on-balance sheet netting
exists, the treatment follows
the
standardised
approach, as set out in paragraphs 200 and 202
to 205.
Exposure
measurement for off-balance sheet items (with
the exception of FX and interestrate, equity,
and commodity-related
derivatives)
310.
For off-balance sheet items, exposure is
calculated as the committed but
undrawn
amount
multiplied by a CCF. There are two approaches
for the estimation of CCFs: a
foundation
approach and an advanced
approach.
EAD
under the foundation
approach
311.
The types of instruments and the CCFs applied to
them are the same as those in
the
standardised approach, as outlined in paragraphs
82 to 89 with the exception of
commitments,
Note Issuance Facilities (NIFs) and Revolving
Underwriting Facilities (RUFs).
312.
A CCF of 75% will be applied to commitments,
NIFs and RUFs regardless of the
maturity
of the underlying facility. This does not apply
to those facilities which are
uncommitted,
that are unconditionally cancellable, or that
effectively provide for
automatic
cancellation,
for example due to deterioration in a borrower’s
creditworthiness, at any time by the bank
without prior notice. A CCF of 0% will be
applied to these facilities.
313.
The amount to which the CCF is applied is the
lower of the value of the
unused
committed
credit line, and the value that reflects any
possible constraining availability of
the
facility,
such as the existence of a ceiling on the
potential lending amount which is related
to
a
borrower’s reported cash flow. If the facility
is constrained in this way, the bank must
have
sufficient
line monitoring and management procedures to
support this contention.
314.
In order to apply a 0% CCF for unconditionally
and immediately cancellable
corporate
overdrafts and other facilities, banks must
demonstrate that they actively
monitor
the
financial condition of the borrower, and that
their internal control systems are such
that
they
could cancel the facility upon evidence of a
deterioration in the credit quality of
the
borrower.
315.
Where a commitment is obtained on another
off-balance sheet exposure,
banks
under
the foundation approach are to apply the lower
of the applicable CCFs.
EAD
under the advanced approach
316.
Banks which meet the minimum requirements for
use of their own estimates of
EAD
(see
paragraphs 474 to 478) will be allowed to use
their own internal estimates of
CCFs
across
different product types provided the exposure is
not subject to a CCF of 100% in
the
foundation
approach (see paragraph 311).
Exposure
measurement for transactions that expose banks
to counterparty credit
risk
317.
Measures of exposure for SFTs and OTC
derivatives that expose banks
to
counterparty
credit risk under the IRB approach will be
calculated as per the rules set forth in Annex 4
of this Framework.
(iv)
Effective maturity (M)
318.
For banks using the foundation approach for
corporate exposures, effective
maturity
(M)
will be 2.5 years except for repo-style
transactions where the effective maturity will
be
6
months. National supervisors may choose to
require all banks in their jurisdiction
(those
using
the foundation and advanced approaches) to
measure M for each facility using
the
definition
provided below.
319.
Banks using any element of the advanced IRB
approach are required to
measure
effective
maturity for each facility as defined below.
However, national supervisors
may
exempt
facilities to certain smaller domestic corporate
borrowers from the explicit
maturity
adjustment
if the reported sales (i.e. turnover) as well as
total assets for the
consolidated
group
of which the firm is a part of are less than
€500 million.
The
consolidated group has to be a domestic company
based in the country where the exemption is
applied. If adopted, national supervisors must
apply such an exemption to all IRB banks using
the advanced approach in that country, rather
than on a bank-by-bank basis. If the exemption
is applied, all exposures to qualifying smaller
domestic firms will be assumed to have an
average maturity of 2.5 years, as under the
foundation IRB approach.
320.
Except as noted in paragraph 321, M is defined
as the greater of one year and
the
remaining
effective maturity in years as defined below. In
all cases, M will be no greater
than
5
years.
•
For
an instrument subject to a determined cash flow
schedule, effective maturity
M
is
defined as:
where
CFt
denotes the cash
flows (principal, interest payments and
fees)
contractually
payable by the borrower in period
t.
•
If a
bank is not in a position to calculate the
effective maturity of the
contracted
payments
as noted above, it is allowed to use a more
conservative measure of M
such
as that it equals the maximum remaining time (in
years) that the borrower is
permitted
to take to fully discharge its contractual
obligation (principal, interest,
and
fees)
under the terms of loan agreement. Normally,
this will correspond to the
nominal
maturity of the instrument.
•
For
derivatives subject to a master netting
agreement, the weighted
average
maturity
of the transactions should be used when applying
the explicit maturity
adjustment.
Further, the notional amount of each transaction
should be used for
weighting
the maturity.
321.
The one-year floor does not apply to certain
short-term exposures, comprising
fully
or nearly-fully
collateralised78 capital market-driven
transactions (i.e. OTC
derivatives
transactions
and margin lending) and repo-style transactions
(i.e. repos/reverse repos and
securities
lending/borrowing) with an original maturity of
less then one year, where the
documentation
contains daily remargining clauses. For all
eligible transactions the
documentation
must require daily revaluation, and must include
provisions that must allow for the prompt
liquidation or setoff of the collateral in the
event of default or failure to
re-margin.
The
maturity of such transactions must be calculated
as the greater of one-day, and
the
effective
maturity (M, consistent with the definition
above).
322.
In addition to the transactions considered in
paragraph 321 above, other
short-term
exposures
with an original maturity of less than one year
that are not part of a bank’s
ongoing
financing of an obligor may be eligible for
exemption from the one-year floor.
After
a careful review of the particular circumstances
in their jurisdictions, national supervisors
should define the types of short-term exposures
that might be considered eligible for this
treatment.
The
results of these reviews might, for example,
include transactions such as:
•
Some
capital market-driven transactions and
repo-style transactions that might
not
fall
within the scope of paragraph
321;
•
Some
short-term self-liquidating trade transactions.
Import and export letters
of
credit
and similar transactions could be accounted for
at their actual remaining
maturity;
•
Some
exposures arising from settling securities
purchases and sales. This
could
also
include overdrafts arising from failed
securities settlements provided that
such
overdrafts
do not continue more than a short, fixed number
of business days;
•
Some
exposures arising from cash settlements by wire
transfer, including
overdrafts
arising
from failed transfers provided that such
overdrafts do not continue more
than
a
short, fixed number of business
days;
•
Some
exposures to banks arising from foreign exchange
settlements; and
•
Some
short-term loans and
deposits.
323.
For transactions falling within the scope of
paragraph 321 subject to a
master
netting
agreement, the weighted average maturity of the
transactions should be used
when
applying
the explicit maturity adjustment. A floor equal
to the minimum holding period for the
transaction type set out in paragraph 167 will
apply to the average.
Where
more than one transaction type is contained in
the master netting agreement a floor equal to
the highest holding period will apply to the
average. Further, the notional amount of each
transaction should be used for weighting
maturity.
324.
Where there is no explicit adjustment, the
effective maturity (M) assigned to
all
exposures
is set at 2.5 years unless otherwise specified
in paragraph 318.
Treatment
of maturity mismatches
325.
The treatment of maturity mismatches under IRB
is identical to that in the
standardised
approach ─ see paragraphs 202 to
205.
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