Basel IV: The Next Generation of Risk Weighted Assets

Content: Foreword 11 Preface 13 1 Revision of the Standardised Approach for Credit Risk 15 1.1 Introduction 15 1.2 Provisions in detail 19 1.2.1 General aspects 19 1.2.2 Claims on banks 20 1.2.3 Exposures to Corporates 24 1.2.4 Specialised lending 28 1.2.5 Subordinated debt instruments, equity and other capital instruments 29 1.2.6 Retail portfolio 30 1.2.7 Exposures secured by real estate/Real estate exposure class 31 1.2.8 Additional risk weights for risk positions with currency mismatch 36 1.2.9 Off-balance-sheet items 37 1.2.10 Defaulted exposures 39 1.2.11 Claims on multilateral development banks (MDB) 39 1.2.12 Other assets 40 1.2.13 Changes in credit risk mitigation techniques 40 1.2.14 Additional aspects and other possible adjustments 43 1.3 Conclusions 44 Recommended Literature 46 2 The Future of the IRB approach 47 2.1 Basel Committee's initiatives to improve the IRB approach 47 2.1.1 Introduction 47 2.1.2 Scope of application of internal models 49 2.1.3 Floors as an instrument of RWA variability reduction 54 2.1.4 Parameter estimation practices 57 2.1.5 Conclusion 58 2.2 Definition of Default 59 2.2.1 Past-due criterion in definition of default 59 2.2.2 Indications of unlikelyness to pay 60 2.2.3 Application of default definition for retail exposures 64 2.2.4 Implications of the default definition for financial institutions 65 2.2.5 Criteria for the return to non-defaulted status 66 2.2.6 Materiality threshold 67 2.2.7 Implementation of changes 67 2.3 Risk estimates 68 2.3.1 Treatment of multiple defaults 69 2.3.2 Default rate 70 2.3.3 PD estimation 71 2.3.4 LGD estimation 71 2.3.5 Downturn adjustment of LGD and conversion factor estimates 72 2.3.6 Implementation of changes in risk estimates 72 2.4 Treatment of defaulted assets 73 2.4.1 Implementation of changes in the treatment of defaulted assets 74 Recommended Literature 75 3 The New Standardised Approach for measuring Counterparty Credit Risk Exposures (SA-CCR) 77 3.1 Counterparty credit risk 77 3.1.1 Definition of the counterparty credit risk 77 3.1.2 Measuring counterparty credit risk according to CRR 78 3.1.3 Background and motives for introducing the SA-CCR approach 79 3.2 Side note: The supervisory measurement of counterparty credit risk within the current exposure method 79 3.3 Measurement of counterparty credit risk according to SA-CCR 83 3.3.1 Exposure at Default 83 3.3.2 Current replacement cost 84 3.3.3 Potential future exposure 85 3.3.4 Calculation example: EAD determination under SA-CCR 97 3.4 Expected impact on the banking industry 98 Recommended Literature 99 4 The New Basel Securitisation Framework 101 4.1 Introduction 101 4.2 Current EU securitisation framework 102 4.2.1 Exclusion of securitised exposures from the calculation of the risk-weighted exposure amounts 102 4.2.2 Approaches for the determination of risk-weighted exposure amounts 104 4.2.3 Regulations for external credit ratings 110 4.3 Revisions to the securitisation framework 110 4.3.1 Criticism of the existing rules 110 4.3.2 Revisions to the securitisation framework 112 4.3.3 Risk weights for securitisation positions when complying with STC criteria 125 4.4 General Conclusions 130 Recommended Literature 131 5 Basel IV for funds 133 5.1 Assignment to the trading book or banking book 135 5.2 Own funds requirements for funds in the banking book 137 5.2.1 Funds under the Standardised Approach 138 5.2.2 Funds under the Internal Ratings-Based Approach (IRB) 140 5.2.3 Leverage Adjustment under the LTA and the MBA 141 5.2.4 Credit Valuation Adjustment 142 5.2.5 Treatment of target funds 143 5.3 Conclusion and impact 144 Recommended Literature 146 6 Fundamental Review of the Trading Book: New Framework for Market Risks. 147 6.1 Introduction 147 6.2 Trading book boundary 148 6.2.1 Revised boundary between the trading and banking book 149 6.2.2 Reallocation 151 6.2.3 Internal Risk Transfer 153 6.3 The revised standardised approach for market price risks 154 6.3.1 Linear and non-linear price risks 155 6.3.2 Default risk 166 6.3.3 Residual risk add-on 167 6.4 Internal Model Approach for market risk (IMA-TB) 167 6.4.1 Regulatory background and goals 168 6.4.2 Procedural and organisational challenges 169 6.4.3 Methodical amendment 169 6.4.4 Impact on capital requirements 176 6.5 Conclusions 179 Recommended Literature 182 7 CVA Risk Capital Charge Framework 183 7.1 Credit Valuation Adjustment 183 7.1.1 Definition of the term "Credit Valuation Adjustment" 183 7.1.2 Background of the regulatory CVA 185 7.1.3 Revision of the CVA framework 185 7.1.4 Hierarchy of approaches 187 7.2 FRTB-CVA framework 188 7.2.1 Regulatory requirements for the application of the FRTB-CVA framework 188 7.2.2 Exposure Value for the FRTB-CVA 191 7.2.3 Standardised approach for CVA (SA-CVA) 194 7.2.4 Internal Model Approach for CVA (IMA-CVA) 197 7.3 Basic CVA framework 198 7.3.1 Side note: Calculation of the CVA Risk Capital Charge under the current standardised method in the CRR 198 7.3.2 Regulatory requirements for the application of the basic CVA framework 202 7.3.3 Exposure Value for the basic CVA 202 7.3.4 Determination of regulatory capital requirements based on the basic CVA framework 202 7.4 Additional aspects and expected effects 206 Recommended literature 208 8 Operational risk. 209 8.1 Background information 209 8.2 Methods to determine operational risk pursuant to Basel II 210 8.2.1 Basic Indicator Approach and Standardised Approach 211 8.2.2 Advanced Measurement Approaches 212 8.3 Criticism of the existing approaches 213 8.4 Operational Risk - Revisions to the simpler approaches (BCBS 291) 214 8.4.1 Requirements for the Revised Standardised Approach 214 8.4.2 The mechanics of the Revised Standardised Approach 214 8.5 Standardised Measurement Approach for operational risk (BCBS 355) 216 8.5.1 Requirements on the SMA 216 8.5.2 Functionality of the SMA 216 8.5.3 Comparison among the BIA, Revised SA (BCBS 291) and SMA (BCBS 355) based on an example calculation 223 8.6 Summary and conclusions 226 Recommended Literature 229 9 Capital Floors 231 9.1 Introduction 231 9.2 Alternatives to design a capital floor 233 9.2.1 Option 1: Risk category-based approach 233 9.2.2 Option 2: Aggregate RWA-based approach 234 9.2.3 Option 3: Floor at exposure class level 235 9.2.4 Treatment of credit risk adjustments 235 9.2.5 Choice of the standardised approach 236 9.2.6 Disclosure 236 9.2.7 Level of floor factor and current discussion 237 9.3 Conclusions 237 Recommended Literature 238 10 New Basel Framework for Large Exposures 239 10.1 Background 239 10.2 Scope 240 10.3 Large exposure limits 240 10.4 Eligible capital 241 10.5 Counterparties and connected counterparties 242 10.6 Definition of exposure 245 10.7 Assessment base 246 10.7.1 On and off-balance sheet items in the banking book 246 10.7.2 Counterparty risk 246 10.7.3 Trading book items 247 10.8 Recognition of credit risk mitigation 247 10.9 Exemptions 249 10.10 Look-through of funds and securitisations 250 10.11 Regulatory reporting 254 10.12 Summary 255 Recommended Literature 258 11 Disclosure 259 11.1 Introduction 259 11.2 Disclosure guidelines 259 11.3 Risk management and risk-weighted assets (RWA) 261 11.4 Linkages between financial statements and regulatory exposures 263 11.5 Credit risk 264 11.5.1 General information on credit risk 265 11.5.2 Credit risk mitigation 267 11.5.3 Credit risk under the standardised approach 268 11.5.4 Credit risk under the IRB approach 268 11.6 Counterparty credit risk 270 11.7 Securitisation 274 11.8 Market risk 275 11.9 Enhancements to the revised Pillar 3 framework and further revisions and additions arising from ongoing reforms to the regulatory policy framework 278 11.9.1 New content 279 11.9.2 BCBS 356: Overview on disclosure by different categories 282 11.9.3 Applicability of existing and prospective BCBS disclosure requirements (second phase of the Pillar 3 review) 282 11.10 Disclosures related to liquidity indicators 283 11.10.1 Disclosure requirements for the Liquidity Coverage Ratio (LCR) 284 11.10.2 The Net Stable Funding Ratio - NSFR (BCBS 324) 285 11.10.3 Additional quantitative and qualitative disclosure requirements 287 11.10.4 Summary and challenges 287 11.11 Conclusions and expected effects 288 Recommended Literature 289 12 Interest Rate Risk in the Banking Book (IRRBB) 291 12.1 Regulatory treatment of interest rate risk in the banking book 291 12.2 The Standardised Framework 292 12.2.1 Introduction 292 12.2.2 Assigning positions to time buckets 293 12.2.3 Interest Rate Shock Scenario Design 295 12.2.4 Estimating the impact on EVE 296 12.2.5 Calculation of minimum capital requirements 296 12.3 Principles for treatment within the framework of Pillar 2 297 12.4 Conclusion and expected impact 297 Recommended literature 299 13 Corporate Governance. 301 13.1 Initial situation 301 13.2 Principles on corporate governance for banks 303 13.2.1 Principle 1: Board's overall responsibilities 303 13.2.2 Principle 2: Board qualifications and composition 306 13.2.3 Principle 3: Board's own structure and practices 307 13.2.4 Principle 4: Senior Management 308 13.2.5 Principle 5: Governance of group structures 309 13.2.6 Principle 6: Risk management function 309 13.2.7 Principle 7: Risk identification, monitoring and controlling 310 13.2.8 Principle 8: Risk communication 311 13.2.9 Principle 9: Compliance 311 13.2.10 Principle 10: Internal audit 312 13.2.11 Principle 11: Compensation 312 13.2.12 Principle 12: Disclosure and transparency 313 13.2.13 Principle 13: The role of supervisors 314 13.3 Conclusions 314 Recommended Literature 316 14 TLAC and MREL - Two initiatives, one goal 317 14.1 Background 317 14.2 The regulations in detail 319 14.2.1 MREL as a new "capital" parameter 319 14.2.2 Scope of application - individual vs. consolidated perspective 319 14.2.3 Responsibility of the "gone-concern" supervisor 320 14.2.4 Eligible Liabilities 321 14.2.5 Deductible items 325 14.2.6 Calibration of the MREL requirement 327 14.2.7 TLAC calibration 331 14.3 Operational impact 332 14.3.1 Preparation 333 14.3.2 Ongoing reporting 333 14.3.3 Management and Pricing 334 14.3.4 Disclosure 334 14.4 Recent developments - TLAC/MREL in the CRR II /CRD V consultation package 335 Recommended Literature 337