The Basel Committee is proposing to restrict the use of internal models to calculate credit risk weights. Comments are due by June 24.
This follows the Committee’s earlier consultations on the standardized approach to credit risk, removing the use of the Advanced Measurement Approach for operational risk, and capital floors; and the revised market risk framework.
We view all these initiatives as part of “Basel 4”, and – contrary to the stated objectives of the Basel Committee – we see them having a significant upward impact on capital requirements for many large banks.
Once finalized, implementing these changes in the EU will require a substantial re-writing of the Capital Requirements Regulation (CRR), so “CRR 2” looms on the not too distant horizon, even before banks have transitioned fully to the CRR.
Remove the option to use internal model approaches for certain exposures, which would become subject to the standardized approach to credit risk:
Introduce a floor to the internal model method for counterparty credit risk, based on a percentage of the applicable standardized approach.
Adopt exposure-level, model-parameter floors to ensure a minimum level of conservatism for portfolios where the IRB approaches remain available – this includes a 10 percent loss given default floor for residential mortgage exposures, and 15 percent for commercial real estate exposures.
Provide greater specification of parameter estimation practices (probability of default, loss given default, exposure at default, maturity and credit risk mitigation) – these constraints are designed to reduce risk weight variability in portfolios where the internal model approaches remain available.