The report finds a reasonable relationship between estimates of probabilities of default and actual default rates. It also evaluates the variability in estimates of exposure at default for all asset classes. These reveal wide variation in bank practices, which can contribute materially to overall RWA variability. It was also found that some of the estimates used in internal credit risk models lack empirical support.
1 April 2016
Bank for International Settlements
Info of the BIS:
The Basel Committee on Banking Supervision published a second report on risk-weighted assets (RWAs) in the banking book, as part of its Regulatory Consistency Assessment Programme (RCAP) to ensure full and effective implementation of the Basel III framework.
The study examines the variability of RWA in banks that use internal models to calculate their credit risk regulatory capital requirements. It follows the Committee’s 2013 report, which found considerable variation in average RWAs for credit risk in the banking book, and extends that analysis in two respects:
- Data were collected from 35 major internationally active banks on their retail and small and medium-sized enterprise (SME) lending portfolios. When averaging across banks in the sample, the report finds a reasonable relationship between estimates of probabilities of default and actual default rates. A weaker relationship is observed between loss outcomes and other parameters estimated by credit risk models (such as loss-given-default). At an individual bank level, there is much greater variation between parameters estimated using credit risk models and actual outcomes. As retail business is predominantly local, these variations are partly explained by differences in local circumstances.
- The report also evaluates the variability in estimates of exposure at default for all asset classes, using data from 37 banks. These reveal wide variation in bank practices, which can contribute materially to overall RWA variability. It was also found that some of the estimates used in internal credit risk models lack empirical support. Further, some data relating to one asset class are being used to support estimates for unrelated asset classes.
The report also describes sound practices relating to banks’ independent model validation functions, as observed during the Committee’s engagement with banks in the course of this study. These practices apply to the governance, methodology and scope of banks’ validation functions, as well as to the role of validation across different phases of model development and implementation.
See also consultation of the BCBS 24 March 2016:
“Reducing variation in credit risk-weighted assets – constraints on the use of internal model approaches”
The consultative document sets out a proposed set of changes to the Basel framework’s advanced internal ratings-based approach and the foundation internal ratings-based approach. The proposed changes to the IRB approaches are a key element of the regulatory reform programme that the Basel Committee has committed to finalise by end-2016.
The proposed changes include a number of complementary measures that aim to: (i) reduce the complexity of the regulatory framework and improve comparability; and (ii) address excessive variability in the capital requirements for credit risk. Specifically, the Basel Committee proposes to:
- remove 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;
- adopt exposure-level, model-parameter floors to ensure a minimum level of conservatism for portfolios where the IRB approaches remain available; and
- provide greater specification of parameter estimation practices to reduce variability in risk-weighted assets for portfolios where the IRB approaches remain available.
See further capital related consultation of the BCBS 6 April 2016:
“Revisions to the Basel III leverage ratio framework“
The Basel III framework introduced a simple, transparent, non-risk based leverage ratio to act as a credible supplementary measure to the risk-based capital requirements. The Basel Committee is of the view that a simple leverage ratio framework is critical and complementary to the risk-based capital framework and that a credible leverage ratio is one that ensures broad and adequate capture of both the on- and off-balance sheet sources of banks’ leverage.
This document sets out the Committee’s proposed revisions to the design and calibration of the Basel III leverage ratio framework. Among the areas subject to proposed revision in this consultative document are:
- measurement of derivative exposures;
- treatment of regular-way purchases and sales of financial assets;
- treatment of provisions;
- credit conversion factors for off-balance sheet items; and
- additional requirements for global systemically important banks.
The final design and calibration of the proposals will be informed by a comprehensive quantitative impact study.