Thursday, March 24, 2016

Basel Proposes Changes to Reduce Variation in Credit Risk Weighted Assets

Author: David Schwartz J.D. CPA

The Basel Committee on Banking Supervision today released a consultative document proposing a set of changes to the Basel III framework’s approaches for determining Banks' regulatory capital requirements for credit risk.  The goals of these changes are to (i) reduce the complexity of the regulatory framework and improve comparability; and (ii) address excessive variability in the capital requirements for credit risk.


The consultative document proposes a set of changes to the Basel framework's advanced internal ratings-based approach and the foundation internal ratings-based approach (IRB approaches). The IRB approaches permit banks to use internal models as inputs for determining their regulatory capital requirements for credit risk, subject to certain constraints. These proposals fine tune the IRB approaches  to address some of the issues believed to be potential drivers of excessive variability in credit risk-weighted assets by:


  • removing the option to use the IRB approaches for certain exposure categories, such as loans to financial institutions, since - in the Committee's view - the model inputs required to calculate regulatory capital for such exposures cannot be estimated with sufficient reliability;
  • adopting exposure-level, model-parameter floors to ensure a minimum level of conservatism for portfolios where the IRB approaches remain available; and
  • providing greater specification of parameter estimation practices to reduce variability in risk-weighted assets for portfolios where the IRB approaches remain available.

This consultation is intended to complement the Committee's previous consultation on the design of capital floors based on standardized approaches, and comments on this consultation will inform the final overall framework. As part of the final design and calibration, the Committee plans a comprehensive quantitative impact study, with the aim "to not significantly increase overall capital requirements."


This set of proposals marks a milestone of sorts.  With the publication of this proposal, the Committee has now consulted on all key elements of its post-crisis regulatory reform programme. Stefan Ingves, Chairman of the Basel Committee on Banking Supervision and Governor of Sveriges Riksbank said "Addressing the issue of excessive variability in risk-weighted assets is fundamental to restoring market confidence in risk-based capital ratios". He added that "the measures announced today largely retain the use of internal models for the determination of credit risk weighted assets, but with important safeguards that will promote sound levels of capital and comparability across banks".


Comments on the consultation are due by Friday, June 24, 2016.