3. Collateral

(i) Eligible financial collateral
145. The following collateral instruments are eligible for recognition in the simple approach:

43 Cash funded credit linked notes issued by the bank against exposures in the banking book which fulfil the criteria for credit derivatives will be treated as cash collateralised transactions.

44 When cash on deposit, certificates of deposit or comparable instruments issued by the lending bank are held as collateral at a third-party bank in a non-custodial arrangement, if they are openly pledged/assigned to the lending bank and if the pledge/assignment is unconditional and irrevocable, the exposure amount covered by the collateral (after any necessary haircuts for currency risk) will receive the risk weight of the third-party bank.

45 However, the use or potential use by a UCITS/mutual fund of derivative instruments solely to hedge investments listed in this paragraph and paragraph 146 shall not prevent units in that UCITS/mutual fund from being eligible financial collateral.

146. The following collateral instruments are eligible for recognition in the comprehensive approach:

(ii) The comprehensive approach

Calculation of capital requirement

147. For a collateralised transaction, the exposure amount after risk mitigation is
calculated as follows:

148. The exposure amount after risk mitigation will be multiplied by the risk weight of the counterparty to obtain the risk-weighted asset amount for the collateralised transaction.

149. The treatment for transactions where there is a mismatch between the maturity of the counterparty exposure and the collateral is given in paragraphs 202 to 205.

150. Where the collateral is a basket of assets, the haircut on the basket will be

Standard supervisory haircuts

151. These are the standard supervisory haircuts (assuming daily mark-to-market, daily
remargining and a 10-business day holding period), expressed as percentages:

46 Includes PSEs which are treated as sovereigns by the national supervisor.

47 Multilateral development banks receiving a 0% risk weight will be treated as sovereigns.

48 Includes PSEs which are not treated as sovereigns by the national supervisor.

49 Eligible cash collateral specified in paragraph 145 (a).

152. The standard supervisory haircut for currency risk where exposure and collateral are denominated in different currencies is 8% (also based on a 10-business day holding period and daily mark-to-market)

153. For transactions in which the bank lends non-eligible instruments (e.g. noninvestment grade corporate debt securities), the haircut to be applied on the exposure should be the same as the one for equity traded on a recognised exchange that is not part of a main index.

Own estimates for haircuts

154. Supervisors may permit banks to calculate haircuts using their own internal estimates of market price volatility and foreign exchange volatility.

Permission to do so will be conditional on the satisfaction of minimum qualitative and quantitative standards stated in paragraphs 156 to 165. When debt securities are rated BBB-/A-3 or higher, supervisors may allow banks to calculate a volatility estimate for each category of security.

In determining relevant categories, institutions must take into account

(a) the type of issuer of the security,

(b) its rating,

(c) its residual maturity, and

(d) its modified duration.

Volatility estimates must be representative of the securities actually included in the category for that bank.

For debt securities rated below BBB-/A-3 or for equities eligible as collateral (lightly shaded boxes in the above table), the haircuts must be calculated for each individual security.

155. Banks must estimate the volatility of the collateral instrument or foreign exchange mismatch individually: estimated volatilities for each transaction must not take into accountthe correlations between unsecured exposure, collateral and exchange rates (see paragraphs 202 to 205 for the approach to maturity mismatches).

Quantitative criteria

156. In calculating the haircuts, a 99th percentile, one-tailed confidence interval is to be used.

157. The minimum holding period will be dependent on the type of transaction and the frequency of remargining or marking to market.

The minimum holding periods for different types of transactions are presented in paragraph 167.

Banks may use haircut numbers calculated according to shorter holding periods, scaled up to the appropriate holding period
by the square root of time formula.

158. Banks must take into account the illiquidity of lower-quality assets.

The holding period should be adjusted upwards in cases where such a holding period would be inappropriate given the liquidity of the collateral.

They should also identify where historical data may understate potential volatility, e.g. a pegged currency.

Such cases must be dealt with by subjecting the data to stress testing.

159. The choice of historical observation period (sample period) for calculating haircuts shall be a minimum of one year. For banks that use a weighting scheme or other methods for the historical observation period, the “effective” observation period must be at least one year (that is, the weighted average time lag of the individual observations cannot be less than
6 months).

160. Banks should update their data sets no less frequently than once every three months and should also reassess them whenever market prices are subject to material changes.

This implies that haircuts must be computed at least every three months.

The supervisor may also require a bank to calculate its haircuts using a shorter observation period if, in the supervisor's judgement, this is justified by a significant upsurge in price volatility.

161. No particular type of model is prescribed. So long as each model used captures all the material risks run by the bank, banks will be free to use models based on, for example, historical simulations and Monte Carlo simulations.

Qualitative criteria

162. The estimated volatility data (and holding period) must be used in the day-to-day risk management process of the bank.

163. Banks should have robust processes in place for ensuring compliance with a documented set of internal policies, controls and procedures concerning the operation of the risk measurement system.

164. The risk measurement system should be used in conjunction with internal exposure limits.

165. An independent review of the risk measurement system should be carried out regularly in the bank’s own internal auditing process.

A review of the overall risk management process should take place at regular intervals (ideally not less than once a
year) and should specifically address, at a minimum:

• the integration of risk measures into daily risk management;

• the validation of any significant change in the risk measurement process;

• the accuracy and completeness of position data;

• the verification of the consistency, timeliness and reliability of data sources used to run internal models, including the independence of such data sources; and

• the accuracy and appropriateness of volatility assumptions.

Adjustment for different holding periods and non daily mark-to-market or remargining

166. For some transactions, depending on the nature and frequency of the revaluation and remargining provisions, different holding periods are appropriate.

The framework for collateral haircuts distinguishes between repo-style transactions (i.e. repo/reverse repos and securities lending/borrowing), “other capital-market-driven transactions” (i.e. OTC derivatives transactions and margin lending) and secured lending. In capital-market-driven transactions and repo-style transactions, the documentation contains remargining clauses; in secured lending transactions, it generally does not.

167. The minimum holding period for various products is summarised in the following table.

168. When the frequency of remargining or revaluation is longer than the minimum, the minimum haircut numbers will be scaled up depending on the actual number of business days between remargining or revaluation using the square root of time formula below:

169. For example, for banks using the standard supervisory haircuts, the 10-business day haircuts provided in paragraph 151 will be the basis and this haircut will be scaled up or down depending on the type of transaction and the frequency of remargining or revaluation using the formula below:

Conditions for zero H

170. For repo-style transactions where the following conditions are satisfied, and the counterparty is a core market participant, supervisors may choose not to apply the haircuts specified in the comprehensive approach and may instead apply a haircut of zero.

This carve-out will not be available for banks using the modelling approaches as described in paragraphs 178 to 181 (i).

50  Note that where a supervisor has designated domestic-currency claims on its sovereign or central bank to be eligible for a 0% risk weight in the standardised approach, such claims will satisfy this condition.

51 This does not require the bank to always liquidate the collateral but rather to have the capability to do so within the given time frame.

171. Core market participants may include, at the discretion of the national supervisor, the following entities:

Read more about our Certified Basel ii Professional (CBiiPro) program

Read more about our Certified Pillar 2 Expert (CP2E) program

Read more about our Certified Pillar 3 Expert (CP3E) program