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D. Rules for Retail
Exposures
326.
Section D presents in detail the method of
calculating the UL capital
requirements
for
retail exposures. Section D.1 provides three
risk-weight functions, one for
residential
mortgage
exposures, a second for qualifying revolving
retail exposures, and a third for
other
retail
exposures. Section D.2 presents the risk
components to serve as inputs to the riskweight
functions. The method of calculating expected
losses, and for determining the
difference
between that measure and provisions is described
in Section III.G.
1.
Risk-weighted assets for retail
exposures
327.
There are three separate risk-weight functions
for retail exposures, as defined
in
paragraphs
328 to 330. Risk weights for retail exposures
are based on separate
assessments
of PD and LGD as inputs to the risk-weight
functions. None of the three
retail
risk-weight
functions contains an explicit maturity
adjustment. Throughout this section,
PD
and
LGD are measured as decimals, and EAD is
measured as currency (e.g.
euros).
(i)
Residential mortgage
exposures
328.
For exposures defined in paragraph 231 that are
not in default and are secured
or
partly
secured
(79) by
residential mortgages, risk weights will be
assigned based on the
following
formula:
Correlation
(R) = 0.15
Capital
requirement (K) = LGD × N[(1 – R)^-0.5 × G(PD) +
(R / (1 – R))^0.5 × G(0.999)]
–
PD x LGD
Risk-weighted
assets = K x 12.5 x EAD
The
capital requirement (K) for a defaulted exposure
is equal to the greater of zero and
the
difference
between its LGD (described in paragraph 468) and
the bank’s best estimate of
expected
loss (described in paragraph 471). The
risk-weighted asset amount for
the
defaulted
exposure is the product of K, 12.5, and the
EAD.
(79) This means that risk weights
for residential mortgages also apply to the
unsecured portion of such residential
mortgages.
(ii)
Qualifying revolving retail
exposures
329.
For qualifying revolving retail exposures as
defined in paragraph 234 that are not
in
default,
risk weights are defined based on the following
formula:
Correlation
(R) = 0.04
Capital
requirement (K) = LGD × N[(1 – R)^-0.5 × G(PD) +
(R / (1 – R))^0.5 × G(0.999)]
–
PD x LGD
Risk-weighted
assets = K x 12.5 x EAD
The
capital requirement (K) for a defaulted exposure
is equal to the greater of zero and
the
difference
between its LGD (described in paragraph 468) and
the bank’s best estimate of
expected
loss (described in paragraph 471). The
risk-weighted asset amount for
the
defaulted
exposure is the product of K, 12.5, and the
EAD.
(iii)
Other retail exposures
330.
For all other retail exposures that are not in
default, risk weights are assigned
based
on
the following function, which allows correlation
to vary with PD:
Correlation
(R) = 0.03 × (1 – EXP(-35 × PD)) / (1 –
EXP(-35)) +
0.16
× [1 – (1 – EXP(-35 × PD))/(1 –
EXP(-35))]
Capital
requirement (K) = LGD × N[(1 – R)^-0.5 × G(PD) +
(R / (1 – R))^0.5 × G(0.999)]
–
PD x LGD
Risk-weighted
assets = K x 12.5 x EAD
The
capital requirement (K) for a defaulted exposure
is equal to the greater of zero and
the
difference
between its LGD (described in paragraph 468) and
the bank’s best estimate of
expected
loss (described in paragraph 471). The
risk-weighted asset amount for
the
defaulted
exposure is the product of K, 12.5, and the EAD.
Illustrative risk weights are shown in Annex
5.
2. Risk
components
(i)
Probability of default (PD) and loss given
default (LGD)
331.
For each identified pool of retail exposures,
banks are expected to provide
an
estimate
of the PD and LGD associated with the pool,
subject to the minimum
requirements
as
set out in Section III.H. Additionally, the PD
for retail exposures is the greater of the
oneyear PD associated with the internal borrower
grade to which the pool of retail exposures is
assigned or 0.03%.
(ii)
Recognition of guarantees and credit
derivatives
332.
Banks may reflect the risk-reducing effects of
guarantees and credit
derivatives,
either
in support of an individual obligation or a pool
of exposures, through an adjustment
of
either
the PD or LGD estimate, subject to the minimum
requirements in paragraphs 480
to
489.
Whether adjustments are done through PD or LGD,
they must be done in a
consistent
manner
for a given guarantee or credit derivative
type.
333.
Consistent with the requirements outlined above
for corporate, sovereign, and
bank
exposures,
banks must not include the effect of double
default in such adjustments.
The
adjusted
risk weight must not be less than that of a
comparable direct exposure to
the
protection
provider. Consistent with the standardised
approach, banks may choose not
to
recognise
credit protection if doing so would result in a
higher capital requirement.
(iii)
Exposure at default
(EAD)
334.
Both on and off-balance sheet retail 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.
335.
On-balance sheet netting of loans and deposits
of a bank to or from a retail
customer
will be permitted subject to the same conditions
outlined in paragraph 188 of
the
standardised
approach. For retail off-balance sheet items,
banks must use their own
estimates
of CCFs provided the minimum requirements in
paragraphs 474 to 477 and 479
are
satisfied.
336.
For retail exposures with uncertain future
drawdown such as credit cards,
banks
must
take into account their history and/or
expectation of additional drawings prior to
default in their overall calibration of loss
estimates. In particular, where a bank does not
reflect conversion factors for undrawn lines in
its EAD estimates, it must reflect in its LGD
estimates the likelihood of additional drawings
prior to default. Conversely, if the bank does
not incorporate the possibility of additional
drawings in its LGD estimates, it must do so in
its
EAD
estimates.
337.
When only the drawn balances of retail
facilities have been securitised, banks
must
ensure
that they continue to hold required capital
against their share (i.e. seller’s interest)
of
undrawn
balances related to the securitised exposures
using the IRB approach to credit
risk.
This
means that for such facilities, banks must
reflect the impact of CCFs in their
EAD
estimates
rather than in the LGD estimates.
For
determining the EAD associated with the seller’s
interest in the undrawn lines, the undrawn
balances of securitised exposures would be
allocated between the seller’s and investors’
interests on a pro rata basis, based on the
proportions of the seller’s and investors’
shares of the securitised drawn balances. The
investors’ share of undrawn balances related to
the securitised exposures is subject to the
treatment in paragraph 643.
338.
To the extent that foreign exchange and interest
rate commitments exist within a
bank’s
retail portfolio for IRB purposes, banks are not
permitted to provide their
internal
assessments
of credit equivalent amounts. Instead, the rules
for the standardised approach
continue
to apply.
E. Rules
for Equity
Exposures
339.
Section E presents the method of calculating the
UL capital requirements for
equity
exposures.
Section E.1 discusses (a) the market-based
approach (which is further
subdivided
into
a simple risk weight method and an internal
models method), and (b) the
PD/LGD
approach. The risk components are provided in
Section E.2. The method of
calculating
expected losses, and for determining the
difference between that measure
and
provisions
is described in Section III.G.
1.
Risk-weighted assets for equity
exposures
340.
Risk-weighted assets for equity exposures in the
trading book are subject to the
market
risk capital rules.
341.
There are two approaches to calculate
risk-weighted assets for equity exposures
not
held
in the trading book: a market-based approach and
a PD/LGD approach. Supervisors will decide which
approach or approaches will be used by banks,
and in what circumstances.
Certain
equity holdings are excluded as defined in
paragraphs 356 to 358 and are subject
to
the
capital charges required under the standardised
approach.
342.
Where supervisors permit both methodologies,
banks’ choices must be made
consistently,
and in particular not determined by regulatory
arbitrage considerations.
(i)
Market-based approach
343.
Under the market-based approach, institutions
are permitted to calculate the
minimum
capital requirements for their banking book
equity holdings using one or both of two
separate and distinct methods: a simple risk
weight method or an internal models
method.
The
method used should be consistent with the amount
and complexity of the
institution’s
equity
holdings and commensurate with the overall size
and sophistication of the
institution.
Supervisors
may require the use of either method based on
the individual circumstances of
an
institution.
Simple
risk weight method
344.
Under the simple risk weight method, a 300% risk
weight is to be applied to
equity
holdings
that are publicly traded and a 400% risk weight
is to be applied to all other
equity
holdings.
A publicly traded holding is defined as any
equity security traded on a
recognised
security
exchange.
345.
Short cash positions and derivative instruments
held in the banking book are
permitted
to offset long positions in the same individual
stocks provided that these
instruments
have been explicitly designated as hedges of
specific equity holdings and
that
they
have remaining maturities of at least one year.
Other
short positions are to be treated as if they are
long positions with the relevant risk weight
applied to the absolute value of each position.
In the context of maturity mismatched positions,
the methodology is that for corporate
exposures.
Internal
models method
346.
IRB banks may use, or may be required by their
supervisor to use, internal
risk
measurement
models to calculate the risk-based capital
requirement. Under this
alternative,
banks
must hold capital equal to the potential loss on
the institution’s equity holdings
as
derived using
internal value-at-risk models subject to the
99th percentile,
one-tailed
confidence
interval of the difference between quarterly
returns and an appropriate
risk-free
rate
computed over a long-term sample period. The
capital charge would be
incorporated
into
an institution’s risk-based capital ratio
through the calculation of risk-weighted
equivalent assets.
347.
The risk weight used to convert holdings into
risk-weighted equivalent assets
would
be
calculated by multiplying the derived capital
charge by 12.5 (i.e. the inverse of
the
minimum
8% risk-based capital requirement).
Capital
charges calculated under the internal models
method may be no less than the capital charges
that would be calculated under the simple risk
weight method using a 200% risk weight for
publicly traded equity holdings and a 300% risk
weight for all other equity holdings. These
minimum capital charges would be calculated
separately using the methodology of the simple
risk weight approach.
Further,
these minimum risk weights are to apply at the
individual exposure level rather than at the
portfolio level.
348.
A bank may be permitted by its supervisor to
employ different market-based
approaches
to different portfolios based on appropriate
considerations and where the
bank
itself
uses different approaches
internally.
349.
Banks are permitted to recognise guarantees but
not collateral obtained on an
equity
position wherein the capital requirement is
determined through use of the marketbased
approach.
(ii)
PD/LGD approach
350.
The minimum requirements and methodology for the
PD/LGD approach for equity
exposures
(including equity of companies that are included
in the retail asset class) are
the
same
as those for the IRB foundation approach for
corporate exposures subject to
the
following
specifications:
(80)
•
The
bank’s estimate of the PD of a corporate entity
in which it holds an equity
position
must satisfy the same requirements as the bank’s
estimate of the PD of a
corporate entity
where the bank holds
debt.81 If a bank does not
hold debt of the
company
in whose equity it has invested, and does not
have sufficient information
on
the position of that company to be able to use
the applicable definition of
default
in
practice but meets the other standards, a 1.5
scaling factor will be applied to
the
risk
weights derived from the corporate risk-weight
function, given the PD set by
the
bank.
If, however, the bank’s equity holdings are
material and it is permitted to use
a
PD/LGD
approach for regulatory purposes but the bank
has not yet met the relevant
standards,
the simple risk-weight method under the
market-based approach will
apply.
•
An
LGD of 90% would be assumed in deriving the risk
weight for equity
exposures.
•
For
these purposes, the risk weight is subject to a
five-year maturity
adjustment
whether
or not the bank is using the explicit approach
to maturity elsewhere in its
IRB
portfolio.
(80)
There is no advanced approach for equity
exposures, given the 90% LGD
assumption.
(81) In practice, if there is both
an equity exposure and an IRB credit exposure to
the same counterparty, a default on the credit
exposure would thus trigger a simultaneous
default for regulatory purposes on the equity
exposure.
351.
Under the PD/LGD approach, minimum risk weights
as set out in paragraphs 352
and
353 apply. When the sum of UL and EL associated
with the equity exposure results
in
less
capital than would be required from application
of one of the minimum risk weights,
the
minimum
risk weights must be used.
In
other words, the minimum risk weights must be
applied, if the risk weights calculated
according to paragraph 350 plus the EL
associated with the equity exposure multiplied
by 12.5 are smaller than the applicable minimum
risk weights.
352.
A minimum risk weight of 100% applies for the
following types of equities for as
long
as
the portfolio is managed in the manner outlined
below:
•
Public equities where
the investment is part of a long-term customer
relationship,
any
capital gains are not expected to be realised in
the short term and there is no
anticipation
of (above trend) capital gains in the long term.
It is expected that in
almost
all cases, the institution will have lending
and/or general banking
relationships
with the portfolio company so that the estimated
probability of default is
readily
available. Given their long-term nature,
specification of an appropriate
holding
period for such investments merits careful
consideration. In general, it
is
expected
that the bank will hold the equity over the long
term (at least five years).
•
Private equities
where the returns on the investment are based on
regular and
periodic
cash flows not derived from capital gains and
there is no expectation of
future
(above trend) capital gain or of realising any
existing gain.
353.
For all other equity positions, including net
short positions (as defined in
paragraph
345),
capital charges calculated under the PD/LGD
approach may be no less than the capital charges
that would be calculated under a simple risk
weight method using a 200% risk weight for
publicly traded equity holdings and a 300% risk
weight for all other equity
holdings.
354.
The maximum risk weight for the PD/LGD approach
for equity exposures is 1250%.
This
maximum risk weight can be applied, if risk
weights calculated according to
paragraph
350
plus the EL associated with the equity exposure
multiplied by 12.5 exceed the
1250%
risk
weight. Alternatively, banks may deduct the
entire equity exposure amount, assuming
it
represents
the EL amount, 50% from Tier 1 capital and 50%
from Tier 2 capital.
355.
Hedging for PD/LGD equity exposures is, as for
corporate exposures, subject to
an
LGD
of 90% on the exposure to the provider of the
hedge. For these purposes
equity
positions
will be treated as having a five-year
maturity.
(iii)
Exclusions to the market-based and PD/LGD
approaches
356.
Equity holdings in entities whose debt
obligations qualify for a zero risk weight
under
the
standardised approach to credit risk can be
excluded from the IRB approaches to
equity
(including
those publicly sponsored entities where a zero
risk weight can be applied), at
the
discretion
of the national supervisor. If a national
supervisor makes such an exclusion
this
will
be available to all banks.
357.
To promote specified sectors of the economy,
supervisors may exclude from
the
IRB
capital charges equity holdings made under
legislated programmes that
provide
significant
subsidies for the investment to the bank and
involve some form of government
oversight
and restrictions on the equity investments.
Example of restrictions are
limitations
on
the size and types of businesses in which the
bank is investing, allowable amounts
of
ownership
interests, geographical location and other
pertinent factors that limit the
potential
risk
of the investment to the bank. Equity holdings
made under legislated programmes
can
only
be excluded from the IRB approaches up to an
aggregate of 10% of Tier 1 plus Tier
2
capital.
358.
Supervisors may also exclude the equity
exposures of a bank from the
IRB
treatment
based on materiality. The equity exposures of a
bank are considered material if
their
aggregate value, excluding all legislative
programmes discussed in paragraph
357,
exceeds,
on average over the prior year, 10% of bank's
Tier 1 plus Tier 2 capital.
This
materiality
threshold is lowered to 5% of a bank's Tier 1
plus Tier 2 capital if the
equity
portfolio
consists of less than 10 individual holdings.
National supervisors may use
lower
materiality
thresholds.
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