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transcript
Credit Risk - Standardised Approach
Belgian Bankers AcademyPrague, October 2005
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Agenda
1. Introduction to Basle II• Scope of Application• Basel I and II• Overview of Minimum Capital Requirements• Standardised versus IRB Approach• Partial Use
2. Minimum Capital Requirements for Credit Risk: Standardised Approach• Exposure Classes• External Ratings and Risk Weights• Credit Risk Mitigation
• Guarantees and Credit Derivatives• Collateral
• Examples
3. Questions and Answers
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Internationally active Banks
Basel
Banks within the European Union
EU
Range of application of the Basel framework in the Czech Republic
Banks in CzechRepublic
“CNB“
”Good Conduct” “Mandatory” “Mandatory”
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The Basel Committee
• The BCBS was formed in 1974 by the Group of 10 central bank governors following the failure of West German bank Bankhaus Herstatt
• Committee members include representatives from Belgium, Canada, France, Germany, Italy, Japan, Luxembourg, the Netherlands, Spain, Sweden, Switzerland, the U.K. and the U.S.
• From its inception, its primary mission has been to promote stability in the global banking system in the pursuit of two guiding principles
• No foreign banking system should escape supervision
• Supervision must be adequate for all banks operating internationally
• Its primary objective is to formulate standards, guidelines and best practices that individual authorities will implement
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Regulatory Capital
Economic Capital≠
• Lack of differentiation within credit risk
• Limited recognition of risk mitigation instruments
• No explicit consideration of other risks
Deficiencies of the current regulatory framework (Basel I)
„Regulatory Arbitrage“
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Concept of Basel II – Three pillar architecture
Qualitative assessment
SupervisoryReview-Process
• Fulfilment of qualitative requirements• Not fully captured risk• Risks not taken into account• External factors
Market-Discipline
Disclosure
• Approaches chosen by the bank• Relevant information
MinimumCapital requirements
Requirements
• Risk weighting/Rating• Risk mitigation• Operational risk
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Basel 2 - Evolution
1960 1970 1980 1990 2000 2001 2002 2003 2005 20062004
3-6-3 principle
Liberalisation
1974: G10 launch Basel Committee
1988: Basel I Accord
1990: 100 countries apply Basel I
1996: Market riskJune/1999: CP1
Jan/2001: CP2
Apr&May: QIS1,2
Nov: QIS2,5
Oct: QIS3
May: Release of CP3
July: QIS3 resultspublished
June 2004: the new Accordpublished
Jan: start parallel run
Jan: Basel 2 comes in force
2007
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Scope of Basel II framework
No general reduction of the capital level in the financial system
Promote safety and soundness in the financial system
Continue to enhance competitive equalityWhat?
Complete recognition of all types of risk
Orientation on the bank‘s individual risk profileHow?
Focus on internationally active banks
Principles suitable for application on smaller banksWho?
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Pillar I
Pillar IPillar II Pillar III
Credit risk Securitization Operational Risk
SA IRB
FIRB AIRB
SA IRB BIA SAAMA
Exceptions RBA IAA SFA
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Implementation schedule for Basel II
01.01.06 01.01.07 01.01.08 01.01.09 01.01.10
F-IRB (incl. Retail)
Advanced approaches for credit risk and/or operational risk
Parallel run Floor (95 %) Floor (90 %) Floor (80 %)
Parallel run
Standardised approach
Start of Basel II(Standardised and Foundation) Start of Basel II
(Advanced and AMA)
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Implementation schedule for EU-Directives
01.01.06 01.01.07 01.01.08 01.01.09 01.01.10
F-IRB (incl. Retail)
Advanced approaches for credit risk and/or operational risk
Floor (95 %) Floor (90 %) Floor (80 %)
Basel I-weighting
Standardised approach
Start of Basel II(Standardised and Foundation) Start of Basel II
(Advanced and AMA)
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Data history for IRB
Retail corporate,sovereigns,banks
PD
LGD
EAD
Basic requirement
Basic requirement
Transition Transition
5 Years 5 Years
5 Years
5 Years
2 Years
2 Years
2 Years
2 Years
7 Years
7 Years
7 Years
7 Years
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Calculation of minimum capital requirements
> 8%Risk weighted assets* + [(Market Risk + Operational Risk) x 12.5]
Regulatory Capital
• Definition of the regulatory capital
• Minimum total capital ratio of 8% to risk weighted assets
• Techniques for market risk assessment
No changes• Techniques for credit risk
assessment
• Operational Risk
• Capital elements within the IRB-Approach (shortfall/excess ofProvisions)
New
* For IRB-Part of RWA a Scaling Factor of 1.06 applies
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Externally provided
Possible approaches for credit risk
CollateralGuaranteesCredit derivativesNetting
Externally providedNo limitation
No consideration**Exceptions: Option 2 Banks Orig. Mat. < 3M and Risk Mitigation/Haircuts
2.5 Y 1 - 5 Years
Calculation methods
Externally provided Externally provided
Externally provided Internal procedures
Externally provided
External/internal Haircuts
Option
Effort
Standardised Internal Ratings Based
Simple Comprehensive
Foundation AdvancedApproach
Risk weighting External ratingsInternal estimation
Externally provided
Maturity
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Partial Use of IRB in the EU
• Exposure to Sovereigns, if number of relevant counterparties is limited and set-up of a rating system would be unnecessary burdensome
• Exposure to banks, if number of relevant counterparties is limited and set-up of a rating system would be unnecessary burdensome
• Exposure to non essential businesses, and exposure to small sized businesses (Participations <10% of own funds, if less then 10 participations<5%)
• Exposures to Central Governments (of originating Member States) and their instrumentalities (assuming the same risk profile)
• Intra Conglomerate exposure
• Participations with risk weight 0%
• Participations in Governmental framework programs for the benefit of specific sectors in the economy.
Permanent partial use is acceptable
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Agenda
1. Introduction to Basle II• Scope of Application• Basel I and II• Overview of Minimum Capital Requirements• Standardised versus IRB Approach• Partial Use
2. Minimum Capital Requirements for Credit Risk: Standardised Approach• Exposure Classes• External Ratings and Risk Weights• Credit Risk Mitigation
• Guarantees and Credit Derivatives• Collateral
• Examples
3. Questions and Answers
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EU: Standardized approach: exposureclasses
Exposure classes
1. Each exposure shall be assigned to one of the following exposure classes:(a) claims or contingent claims on central governments or central banks;(b) claims or contingent claims on regional governments or local authorities;(c) claims or contingent claims on administrative bodies and non-commercial undertakings;(d) claims or contingent claims on multilateral development banks;(e) claims or contingent claims on international organisations;(f) claims or contingent claims on institutions;(g) claims or contingent claims on corporates;(h) retail claims or contingent retail claims;(i) claims or contingent claims secured on real estate property;(j) past due items;(k) items belonging to regulatory high-risk categories;(l) claims in the form of covered bonds;(m) securitisation positions;(n) short-term claims on institutions and corporate;(o) claims in the form of collective investment undertakings (CIU);(p) other items. Article 79 and Annex VI
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• For the purpose of capital requirement calculation, the exposure value is determined as follows:
• The conversion factor value for the off-balance item is• 100% for a “full risk” item (e.g. irrevocable bank guarantee)• 50% for a “medium risk” item (e.g. undrawn credit facility with maturity
over one year)• 20% for a “medium/low risk” item (e.g. letter of credit with goods as
collateral)• 0% for a “low risk” item (e.g. unconditionally cancelable credit facility)
• A detailed list of off-balance sheet items with corresponding conversion factors is introduced in Annex II.
EAD = Part of position in balance-sheet + Part of position off balance-sheet × Conversion factor
EAD assessment: General rule
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Standardised approach Risk weighting
1 Assessment of Export credit agencies only for claims on sovereigns/central government2 Risk weighting corresponding to the sovereign risk weighting of the respective country3 Risk weighting corresponding to the individual banks4 Short term claims (original maturity < 3 months) get a one category more favourable risk weighting5 At national discretion, supervisory authorities may permit banks to risk weight all corporate claims at 100% without regard at external ratings6 For example, commercial paper
Claim
Sovereigns
Rating S&P and Export credit agencies1
Option 12
Option 23
Corporates5
Banks
AAA to AA- A+ to A- BBB+
to BBB- BB+ to B- Below B-“Unrated”
0% 20% 50% 100% 150% 100%
20%
20%
20%
50%50%
50% 100%
100%50%
100%
100%
150%
150%
150%
100%
100%
50%
AAA to AA- A+ to A- BBB+
to BB- Below BB- “Unrated”
Option 34 20% 20%320%3 50%3 150% 20%
1 2 3 4-6 7
Short term6 20% 100%50% 150%
A1 / P1 A2 / P2 A3 / P3 Others
Other position 100% Retail 75%
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EU: Standardized approach
Credit quality steps
Exposure to Sovereigns
Method 11
Method 22Exposure to banks
2 3 4 5 6„Unrated“
20% 50% 100% 100% 150% 100%
50% 100%50% 100% 150% 50%
Method 33 20% 50%320%3 50%3 150% 20%
2 3 4 5-6 7
1
0%
20%
20%
1Minimum export insurancepremiums (MEIP)
50% 100% 100% 100% 150% 100%20%
Mortgage backed securities 20% 20%/50%4 20%/50%4 50% 100% 20%/50%410%
Exposure to Corporate 50% 100% 100% 150% 150% 100%20%Short term exposuresto banks/corporates 50% 100% 150% 150% 150%20%
Exposure to CIUS 50% 100% 100% 150% 150% 100%20%
Other exposures 100%
Retail 75%
Commercial real estate 50%
Housing credits 35%
1 (Option 1 in Basel II)2 Rating based Method ( Option 2 in Basel II)3 Short term option4 At discretion of the Regulator
Annex VI
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Exposures to local governments, PSE, multilateral development banks and international organizations I
• Exposures to local governments and local authorities are treated as exposures to banks unless the national regulator has allowed them to be treated as exposures to sovereigns.
• Claims or contingent claims on administrative bodies and non-commercial undertakings (PSE – Public Sector Entities) are assigned RW = 100%, unless the national regulator has allowed them to be treated as exposures to institutions.
• Exposures to multilateral development banks and international organizations are treated as banks.
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Exposures to local governments, PSE, multilateral development banks and international organizations II• The following banks and organizations are assigned RW = 0%:
• International Bank for Reconstruction and Development• International Finance Corporation• Inter-American Development Bank• Asian Development Bank• African Development Bank• Council of Europe Development Bank• Nordic Investment Bank• Caribbean Development Bank• European Bank for Reconstruction and Development• European Investment Bank• European Investment Fund• Multilateral Investment Guarantee Agency
• The following 3 international organizations also have a RW = 0%:• European Communities (EC)• International Monetary Fund (IMF)• Bank for International Settlements (BIS)
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External Credit Assessment Institution (ECAI) ratings I
The national regulator has the discretion to assess the suitability of the External Credit Assessment Institution, ECAI, (but CEBS ruling)
Approval procedure
The criteria for approving an external agency (ECAI) by a regulator:• objectivity• independence• ongoing review• the resulting ratings meet the requirements for credibility and transparency
and are accepted by the market
General criteria
Annex VI part 2
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External Credit Assessment Institution (ECAI) ratings II
The national EU regulator, with due consideration of the CEBS guidelines, has the authority to approve rating agencies.
The national regulator shall determine to which of the further specified credit quality steps (CQS) will be associated specific credit assessments of individual approved rating agencies. The result will be the mapping of risk weights (RW) to the determined grades.
Banks must use their selected ECAI and its ratings for all exposure types (no “cherry picking“).
Minimum annual disclosure of: • What ECAIs for what type of exposure• The procedure of the regulator to grant approval
Principles
Article 81 and following ones. Annex VI part 2 and Annex XII part 2 p.6
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The higher oneTwo ratings with diverging risk weights
If two of the lowest ones are identical, that risk weight is the eligible
Rating.If not, the higher one of
the two ratings
More than two ratings with diverging risk weights
If several ECAIs rate the same debtor
Selection of Ratings
Annex VIII part 1 p. 10
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Intra Group (Conglomerate) exposure
• The counterparty is a credit institution, Financial Holding Company, Financial institution, Asset Management Company under an acceptable Supervision.
• Both parties must be consolidating their balance sheets
• Share the same risk assessment, control and management
• Registered Office of the counterparty in the same Member State
• No substantial, legal or whatever impediment to transfer own funds between the counterparts
Requirements:
0%-at national discretion possible
article 80, paragraph 7
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Standardised approach: Retail loans
Qualitative requirements:
Quantitative requirements:
Definition of a Retail portfolio• private individuals• smaller companies• ...
• Max single credit of €1 million• Sufficient diversification of the Retail
portfolio (Possibility: Max credit volume of 0.2% of total Retail Portfolio)
Capital relief: Standard risk weighting of 75%
article 79, paragraph 2
Possible problems: Credits higher than “1.01” mill. €
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Commercial real estate
Claims secured by real estate
Risk weight for loans secured entirely by residential property/mortgages on residential real estate:
35%
Residential real estate
Exception
Risk weight for loans secured by commercial property/mortgages on commercial real estate:
In highly-developed and long-established markets:
• Min [50% of MV*; 60% of LV*]
• Loan amount minus Min [50% of MV*; 60% of LV*]
Principle
* Market value (MV) or lending value (LV) of the securing property
100%
100%
50%
Conditions (to be added):
• Losses resulting from commercial real estate loans, up to the lower value of either 50% of MV or 60% of LV, must be < 0.3% of the yearly outstanding loans
• Total losses from commercial real estate loans must be < 0.5% of the yearly outstanding loans
Risk weight
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Units shares of CIUS
• If a rating exists for a unit share of a CIUS the table must be applied• High risk CIUS may bear a 150% risk weight
annex VI, part 1, p.71 and following
• CIUS Management company located in the EU
• Management company under an acceptable Regulator, exchange of info assumed
• Prospectus has info on asset composition and investment restrictions
• Annual reporting minimum
• Is it possible to assess the existing exposure, is it possible to determine an average exposure amount
• Risk weighting could be based on investment restrictions
• Third parties could be appointed to assess the risk exposure of the CIUS
At CIUS level: Determination of rating
Qualitative requirements
Base
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Treatment of higher-risk assets
Other higher risk weights• Securitisation tranches rated between BB+ an BB- risk weighted at 350%• National supervisors may decide to apply a 150% or higher risk weight reflecting the higher
risks associated with some other assets, such as venture capital and private equity investments
1 Claims that are more than 90 days past due are not allowed to be allocated to the Retail portfolio if the granularitycriterion is used as evidence for a sufficient diversification
2 Fully secured by those forms of collateral that are not recognised as eligible credit risk mitigation techniques3 At national discretion
< 15% 15-20% 20-50% > 50%
Residential mortgage loans 100% 100% 50% 50%3
Other collateral2 150% 100% 100% 50%3
Other 150% 150% 100% 50%3
Specific provisionsLoans more than 90 days past due1
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Off-balance sheet transactions
Risk weight dependent on:• Type of counterpart (sovereign/central bank, bank, corporate)• External rating of the counterpart
OTC-derivatives
• Irrevocable commitments with an original maturity of up to one year
• Commitments which can unconditionally be cancelled by the bank at any time
• Commitments which are automatically cancelled at any time as a result of a deterioration in the borrower’s creditworthiness, without any prior notice from the bank
Prin
cipl
e
0%
20%
• Irrevocable commitments with an original maturity longer than one year 50%
Credit conversionfactor
Creditcommitment
Exce
ptio
ns
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Overview standardized approach risk weightings
<100%: if an acknowledged rating is available
150%: credits granted deferred > 90 daysExceptions
150%: high risk items
150%: bad rating
75%: Retail credits
50%: Commercial real estate mortgage backed credits
35%: Housing mortgages backed credits
Basic rate: 100%
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Credit Risk Mitigation: General Provisions
• Institutions using both the standardized approach, or foundation IRB, may take into consideration the effect of Credit Risk Mitigation (CRM) during RW calculation.
• All possible credit risk mitigation methods must be legally enforceable in all relevant countries.
• In addition, institutions must ensure the efficiency of the entire process and address risks connected therewith.
• Institutions must always ensure compliance with minimum requirements for CRM procedures.
• If all defined requirements are met, the institution may decrease the value of RW or EL in compliance with CAD.
• No exposure with a CRM instrument may have a RW higher than an identical, but unprotected exposure.
• In cases when CRM has been incorporated in the calculation of RWA, the provision on CRM is not further applied.
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Approach to credit risk mitigation
CollateralCredit derivatives
Netting(balance sheet items)
Risk mitigation techniques have developed considerably since the implementation of the original Accord
• Appropriate treatment of residual risks
• Reduction in the capital requirement
• Balance between accuracy and complexity
Principle:
Goals:
Instruments: Guarantees
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Eligible collateral in the standardised approach - I
CollateralsSimple Approach Comprehensive Approach• Cash on deposit / Gold• Debt securities with credit quality step (CQS) not worse than
3 (or 4 for sovereigns)
• Debt securities issued by a bank without rating (restrictions apply)
• Equities and convertible bonds that are included in a main index
• CIUS / mutual funds (limited)
• All instruments of the simple approach• Equities and convertible bonds, which are not included
in a main index but are listed on a recognized exchange2
• CIUS / mutual funds (extended)2
• Issued by a bank• Listed on recognised exchange• Senior claim• No other issue of the issuer rated worse lower than „3“
(EU) or „BBB-, A3/P3“ (Basel)• No indication of rating deterioration• Sufficient liquidity
• Daily pricing• Investment only in eligible risk mitigation instruments
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• Claims
• Deposits
• Central banks and sovereigns with lower risk weight than the counterparty
• Public sector (PSEs), banks and securities firms with a lower risk weight than the counterparty
• Multilateral development banks• International organizations (with a 0% RW)• Other entities with CQS 1 or 2• NOT! Guarantees issued by a retail client !
Eligible collateral in the standardisedapproach - II
Guarantees / Credit derivatives Netting
• Life Insurances• Cash lodged at other banks
Possibility to recognise:(as guarantees)
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Risk weight
Conditions (to be added):Losses resulting from commercial real estate loans. up to the lower value of either 50% of MV or 60% of LV. must be < 0.3% of the yearly outstanding loansTotal losses from commercial real estate loans must be < 0.5% of the yearly outstanding loans
100%Loan amount minus Min [50% of MV*; 60% of LV*]
50%In highly-developed and long-established markets: Min [50% of MV*; 60% of LV*]
Exception
100%Risk weight for loans secured by commercial property/mortgages on commercial real estate:
Principle
Eligible collateral in the standardisedapproach - III
Commercial real estate
Risk weight for loans secured entirely by residential property/mortgages on residential real estate: 35%
Residential real estate
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Qualitative requirements for financial collateral
• Legal certainty• Low correlation with exposure• Robust risk management process
• Strategy• Focus on underlying credit• Valuation• Policies. procedures. systems• Concentration risks• Roll-off risks
• Disclosure of information under Pillar III
Annex VIII, Part 2
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Minimum requirements for guarantees and derivatives
• Unrestricted exposure enforcement to guarantors and coverage providers
• Unconditional coverage / Irrevocable commitment
• No unilateral cancellation of commitment of coverage provider possible
• No increase of fees of coverage if underlying exposure is declining
• No reduction in availability of coverage
• Asset-mismatch not acceptable
Requirements
Annex VIII, Part 2
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Requirements for Netting
• Funded legal entitlement, in case of insolvency, bankruptcy etc...
• Quantification of exposure and liabilities• Awareness of residual risk exposure• Management and control of net position
exposure
Instruments • claims• deposits
Qualitative requirements
Calculation • As in the case of acceptance of other financial coverage instruments.
Annex VIII, Part 2
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Residual Regulatory risks
Maturity mismatching Market pricerisk Asset-Mismatch
Risks stemming from insufficient coverage
Discrepancies between assets to be
secured and the underlying notional
assets (credit derivative)
Diverging market price evolution between
exposure and pledged item
Mismatch maturity of pledged asset with
underlying exposure
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Risk mitigation in the Standardised Approach
Collateral Guarantees/credit derivatives
Netting(balance sheet positions)
Comprehensive Approach
Assessment of collateral instruments after consideration of haircuts resulting from residual risks
Haircuts in case of maturity mismatch
Remaining maturity of collateral minimum 3 months
Original maturity of collateral > 1 year
No consideration of maturity mismatches, if the term to maturity of the loan is > 5 years
Simple Approach
Substitution approach with a minimum weighting of 20%
Maturity match required
Collateral assessment minimum every 6 months
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Minimum requirements• Pledge of maturity converging securities
• Valuation of underlying securities all 6 calendar months
Risk weighting• Covered exposure : Risk weighting of the pledged asset
20% Minimum risk weight
• Uncovered exposure: Risk weight of the debtor/ pledge grantor
Exceptions • Transactions undergoing a daily market value valuation and
subject to a daily margin call
• Cash deposits
• Government securities with an assigned 0% risk weight (20% discount on the market value)
Annex VIII, part 3 p.27 and following
Simple approach
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The comprehensive approach
Step 2
Step 1
Calculation of the adjusted value of collateral (CA)Market value of the collateral- haircut for collateral- haircut for FX-risk
= adjusted value of collateral
Calculation of outstanding loan amount (E)
CA = C x (1-Hc-Hfx)
Calculation of the adjusted value of collateral in case of maturity mismatch (CAA)
Step 3CAA = CA x min [1 ; t - 0,25 / (min (5 ; T) - 0,25)]
EA = E x (1+He)Value of the exposure
Step 4 Calculation of the value of the exposure post collateral and post maturity mismatches
E**= max [0; (EA – CAA)]
Step 5 Calculation RWA with r = risk weight of the borrower RWA = E** x r
CAA = CA => E** = E* E*= max [0; (EA – CA)]
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Add-ons and cut-downs
Impact of Haircut depends on
instrument Transactions type Frequency of market valuation and or margin call
• Cash / gold / bonds / shares / investment fund
• Issuer
• Rating
• Remaining maturity
• All Repo type transactions
• Other capital markets transactions
• Covered credit granting
• Number of days elapsing between valuations of underlying assts for covered credits
• Days elapsing before margin call occurring
Add-ons to Exposure (He)
Cut downs on pledged assets (Hc)
Cut downs for FX currencies (Hfx)
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The comprehensive approach - standard supervisory haircuts (Basel II)
FX risk haircutUCITS and mutual fundsCashOther listed sharesShares included in a main index and gold
> 5 years
< 1 year> 1 year, < 5 years
> 5 years
< 1 year> 1 year, < 5 years
> 5 years
< 1 year> 1 year, < 5 years
Issue rating for bonds
Residual maturity Sovereigns(values in %)
Banks/Corporates(values in %)
8Highest haircut applicable to securities in which the fund can invest
02515
3142
0,5
6284
1
151515 6 12
__
_
_
_
_BB+ - BB-
A+ - BBB-/A2/A3
AAA - AA-/A1
Assumptions: (1) daily reassessment of the securities, (2) daily remargining, (3) 10-business day holding period (=TN)
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The comprehensive approach - standard supervisory haircuts (EU)
Assumptions: (1) daily reassessment of the securities
17,6782535,35517,6782535,355Other listed shares
000000Cash
Highest haircut applicable to securities in which the fund can investUCITS and mutual funds
5 days110 days120 days15 days110 days120 days1
N/AN/AN/A10,6071521,213≤ 1 yearCQS 4 N/AN/AN/A10,6071521,213<1 ≤ 5 years
8,4851216,9714,24368,485> 5 years
N/AN/AN/A10,6071521,213> 5 years10,6071521,21310,6071521,213Shares and convertible bonds
in the main index and gold
5,657811,3145,657811,314FX risk haircut
4,24368,4852,12134,243<1 ≤ 5 years1,41422,8280,70711,414≤ 1 year
CQS 2-3
5,657811,3142,82845,657> 5 years2,82845,6571,41422,828<1 ≤ 5 years0,70711,4140,3540,50,707≤ 1 year
CQS 1
Banks/Corporates(values in %)
Sovereigns(values in %)
Residual maturity
Issue rating for bonds
1 Liquidation period
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Calculation of haircuts (H) - I
1. Selection of standard haircuts (H10=HN)
2. Selection of transaction type (TM)
3. Consideration of revaluationintervals (NR) •Daily Revaluation• 20 working daysSecured lending
•Daily Remargining• 10 working daysOther capital market
• 5 working daysRepo-style
•Condition•Holding periodTransaction
•Daily Remargining
FX risk haircut
UCITS and mutual funds
Cash
Other listed shares
Shares included in a main index and gold
> 5 years
< 1 year> 1 year, < 5 years
> 5 years
< 1 year> 1 year, < 5 years
> 5 years
< 1 year> 1year, < 5 years
Issue rating for bonds
Residual maturity Sovereigns(values in %)
Banks/Corporates(values in %)
8
Highest haircut applicable to securities in which the fund can invest
0
25
15
3
1
4
2
0,5
6
2
8
4
1
15
15
15
6 12
_
_
_
_
_
_
BB+ - BB-
A+ - BBB-/A2/A3
AAA - AA-/A1
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Calculation of haircuts (H) - II
4. 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:
H … haircut; HM … haircut under the minimum holding period; TM … minimum holding period for the type of transaction; NR … actual number of business days between remargining for capital market transactions or revaluation
for secured transactions.
When a bank calculates the volatility on a TN day holding period which is different from the specified minimum holding period TM, the HM will be calculated using the square root of time formula:
HN … haircut based on the holding period TNTN … holding period used by the bank for deriving HNTM … minimum holding period
( )M
MRM T
TNHH 1−+=
N
MNM T
THH =
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Calculation of haircuts (H) - III
• Differences between Basel II and EU Directives:• Supervisory volatility adjustments (haircuts) are described
under the EU framework more in further detail• The calculation of haircuts proceeds in the same way,
however there are some differences in terminology, e.g.:“holding period” in Basel II = “liquidation period” in EU
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Exercise 4
Calculate credit amounts outstanding, the adjusted values of the securities, the credit amounts after security underlying and the risk weighted assets for all the following credits (steps 1+2 and 4+5):
credit 1 Mio. Euro corporate Rating BBB, Remaining maturity 4 years, unsecured
credit 1 Mio. Euro corporate Rating BBB, Remaining maturity 4 years, secured 1 Mio. Euro cash
credit 1 Mio. Euro corporate Rating BBB, Remaining maturity 4 years, secured 900.000 USD cash, FX rate Euro/USD 0,90 (daily valuation)
credit 1 Mio. Euro corporate Rating BBB, Remaining maturity 4 years, securedMaturity matching T-Bond Nominal 900.000 Euro (Market value 1,05 Mio. Euro), monthly valuation (= 20 days)
Securities lending (daily valuation, daily re-margining) T-Bond Nominal 1,1 Mio. Euro (Marketvalue 1 Mio. Euro) to a Bank Rated A (Option II), Remaining maturity 6 Months, secured by a pledge on USD denominated T-Bond, Nominal 1 Mio. USD (Market value 972.000 USD, Euro/USD 0,90)
1
2
3
4
5
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Solution 4 (I)
Case 1 (cash credit unsecured)
Case 2 (cash credit secured)
1. Credit amount outstanding E: 1.000.000 €Haircut credit: 0
2. Adjusted value security: 0Market value: 0Haircut Security: 0Haircut currency: 0
4. Secured Credit amount: 1.000.000 €
5. Risk weighted asset: 1.000.000 €Risk weight debtor: 100 %
1. Credit amount outstanding E: 1.000.000 €Haircut credit: 0
2. Adjusted value security: 1.000.000 €Market value: 1.000.000 €Haircut Security: 0Haircut currency: : 0
4. Secured Credit amount: 0 €
5. Risk weighted asset: 0 €Risk weight debtor: 100 %
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Solution 4 (II)
Case 4 (Lombard credit)
1.050.000 € x (1 - 0,0395)= 1.008.528,32 €
= 3,95 %20 + (20-1)
102 % x
Case 3 (cash credit secured in currency)
1.000.000 € x (1 - 0,1131) = 886.900 €
= 11,31 %1 + (20-1)
108 % x
1. Credit amount outstanding E: 1.000.000 €Haircut credit: 0
2. Adjusted value security: 886.900 €Market value: 1.000.000 €Haircut Security: 0Haircut currency: 11,31 %
4. Secured Credit amount: 113.100 €5. Risk weighted asset: 113.100 €
Risk weight debtor: 100 %
1.000.000 € – 886.900 € = 113.100 €
1. Credit amount outstanding E: 1.000.000 €Haircut credit: 0
2. Adjusted value security: 1.008.528 €Market value: 1.050.000 €Haircut Security: 3,95 %Haircut currency: 0
4. Secured Credit amount: 0 €5. Risk weighted asset: 0 €
Risk weight debtor: 100 %
54
Solution 4 (III)
Case 5 (securities lending credit)
= 5,66 %1 + 4
108 % x
1.080.000 € x (1 - 0,0035 - 0,0566) = 1.015.092 €
= 0,35 %1 + 4
100,5 % x
= 0,35 %1 + 4
100,5 % xHC =
HE =
HFX =
1. Credit amount outstanding E: 1.003.500 €Adjusted value security: 0,35 %
2. Adjusted value security: 1.015.092 €Market value: 1.080.000 €Haircut Security: 0,35 %Haircut currency: 5,66 %
4. Secured Credit amount: 0 €
5. Risk weighted asset: 0 €Risk weight debtor: 50 %
55
Exercise 5
Calculate the risk weighted asset, taking the maturity mismatch into account (Steps 1-5)
Cash credit of € 1 mln. to A-rated company, remaining maturity 4 years, collateralized by federal bond with a market value of € 1 mln. (valued monthly) with a remaining maturity of 4 years
Cash credit of € 1 mln. to A-rated company, remaining maturity of 4 years, collateralized by federal bond with a market value of € 1 mln. (valuation monthly) with a remaining maturity of 3 years
Cash credit of € 1 mln. to A-rated company, remaining maturity of 4 years, collateralized by federal bond with a market value of € 1 mln. (valuation monthly) with a remaining maturity of 2 years
Cash credit of € 1 mln. to A-rated company, remaining maturity of 4 years, collateralized by federal bond with a market value of € 1 mln. (valuation monthly) with a remaining maturity of 10 weeks
1
2
3
4
56
Solution 5 (I)
Case 1 (no mismatch)
Case 2 (3-years remaining maturity)
€ 1,000,000 x (1 – 0.0395) = € 960,500
= 3.95%10
HC = 2% x
1. Credit amount outstanding E: € 1,000,000Credit haircut: 0
2. Adjusted value of the collateral: € 960,500Market value of the collateral: € 1,000,000 Collateral haircut: 3.95%Currency haircut: 0
3. Adjusted value of the collateralsafter maturity mismatch: € 960,500
4. Credit amount after collaterals andmaturity mismatch: € 39,500
5. Risk-weighted asset: € 19,750Risk weight of debtor: 50%
€ 1,000,000 - € 960,500 = € 39,500
€ 39,500 x 50% = € 19,750
1. Credit amount outstanding E: € 1,000,000Credit haircut: 0
2. Adjusted value of the collateral: € 960,500Market value of the collateral: € 1,000,000Collateral haircut: 3.95%Currency haircut: 0
3. Adjusted value of the collateralsafter maturity mismatch: € 704,367
4. Credit amount after collaterals andmaturity mismatch: € 295,633
5. Risk weighted asset: € 147,816.50Risk weight of debtor: 50%
Ca = € 960,500 x (2.75/3.75) = € 704,367
€ 1,000,000 - € 704,367 = € 295,633
€ 295,633 x 50% = € 147,816.50
= 3.95%10
HC = 2% x
20 + (20-1)
20 + (20-1)
57
Solution 5 (II)
Case 3 (2-years remaining maturity)
Case 4 (10-weeks remaining maturity)
No collateral recognitionCredit-rating weight = 50%
1. Credit amount outstanding E: € 1,000,000Credit haircut: 0
2. Adjusted value of the collateral: € 960,500 Market value of the collateral: € 1,000,000 Collateral haircut: 3.95%Currency haircut: 0
3. Adjusted value of the collaterals after security mismatch: € 448,233
4. Credit amount after collaterals andmaturity mismatch: € 551,767
5. Risk-weighted asset: € 275,883.5 Risk weight of debtor: 50%
Ca = € 960,500 x (1.75/3.75) = € 448,233
€ 1,000,000 - € 448,233 = € 551,767
€ 551,767 x 50 % = € 275,883.5
1. Credit amount outstanding E: € 1,000,000Credit haircut: 0
2. Adjusted value of the collateral: € 0Market value of the collateral: € 0Collateral haircut : 0%Currency haircut: 0
3. Adjusted value of the collaterals after maturity mismatch: € 0
4. Credit amount after collaterals andmaturity mismatch: € 1,000,000
5. Risk-weighted asset: € 500,000Risk weight of debtor: 50%
= 3.95%10
HC = 2% x20 + (20-1)
58
Apportionment of guarantees and credit derivatives
Principle:Substitution approach
Substitution of the risk weight of the credit user (CU) with the risk weight of the guarantee or collateral provider
Senior / subordinate coverage treated separately
Maturity mismatches (Collateral RP > 3 months)
Adjusted value for guarantee / credit derivative: GA = G x (1 – HfX)
GAA= adjusted value of the collateral aftermaturity mismatch GAA = GA x min [1 ; t – 0.25 / (min (5 ; T) – 0.25)]
RWA = E x gCoverage:
RWA = (E - GAA) x r + GAA x gIf GAA<E (pro rata coverage)
If GAA>Eg = risk weight of the guarantee/collateral provider
In case of credit derivatives, if they do not contain a debt restructuring provision connected with a decrease of payments, the value G is decreased by 40%
59
Exercise 6
Calculate the risk-weighted asset of the credits collateralized with guarantees/ credit derivatives (CD), taking residual risks into account
Cash credit over € 1 mln. to BBB-rated company, collateralized in full by guarantee from an AA-rated bank, maturity matched
Cash credit of € 1 mln. to BBB-rated company, 4 year remaining maturity, collateralized in full by credit derivative of a bank (AA rating) with 3 year remaining maturity
Cash credit of € 1 mln. to BBB-rated company, 4 years remaining maturity, collateralized with pro rata guarantee in of an amount of US$ 720,000 (EUR/USD FX rate 0.90, valuation daily) by an insurance (AAA rated) with 3 years remaining maturity
1
2
3
60
Solution 6 (I)
Case 1 (fully guaranteed)
Case 2 (CD / mismatched maturity)
debtor risk weight: 100%Collateral risk weight: 20%
Exposure: € 1,000,000Credit haircut: 0
Adjusted value for guarantee : € 1,000,000Currency haircut: 0
Adjusted value for guarantee after € 1,000,000maturity mismatch:
Risk-weighted asset: € 200,00020% x € 1,000,000 = € 200,000
debtor risk weight: 100%Collateral risk weight: 20%
Exposure: € 1,000,000Credit haircut: 0
Adjusted value for the CD: € 1,000,000Currency haircut: 0
Adjusted value for the CD after € 733,333maturity mismatch:
Risk-weighted asset: € 413,334
Ca = € 1,000,000 x (2.75/3.75) = € 733,333
(€ 1,000,000 - € 733,333) x 100%
+ € 733,333 x 20% = € 413,334
61
Solution 6 (II)
Case 3 (Guaranteed pro rata with currency and maturity mismatches)
debtor risk weight: 100%Collateral risk weight: 20%
Exposure: € 1,000,000Credit haircut: 0
Adjusted value for guarantee: € 709,520Currency haircut: 11.31%
Adjusted value for the CD aftermaturity mismatch: € 520,315
Risk-weighted asset: € 583,748
Ca = € 709,520 x (2.75/3.75) = € 520,315
(€ 1,000,000 - € 520,315) x 100% + € 520,315 x 20% = € 583,748
= 11.31%1 + (20 -1)
108% x
€ 800,000 x (1-0.1131) = € 709,520
62
Netting of assets
On-balance sheet Netting
Credit and deposits
Standard equation of the approach
Impact determination:
Haircuts
Mismatching maturities
CA = C x (1- Hfx)
CAA = CA x min [1 ; t - 0,25 / (min (5 ; T) - 0,25)]
E**= max[0; (EA – CAA)]
RWA = E** x rCalculated risk weight asset:
63
On-Balance-Sheet Netting (I)
Type Amount in EUR Currency* RLZ
Claim 1.000 EUR 4
Deposit 200 EUR 3
Claim 200 USD 3
Deposit 1000 USD 4
N0
1
2
3
4
The bank has exposures with one counterparty (Rating BB):
Calculation of haircuts on a daily basis *FX rate EUR/USD = 1,00
There is no explicit comment on the order, in which the exposures have to be netted. This order may have effects on the capital requirements.
64
On-Balance-Sheet Netting (II)
Option 1 FX-Priority (Haircuts for maturity mismatches)
Position 1 and 2Position 3 and 4
Option 2
Position 1 and 4 Position 2 and 3
Maturity-Priority (Haircuts for FX-mismatch)
Risk weight Borrower (r): 100 %Exposure (E): 1.000 €Value of collateral (CA): 200 €Adjusted value of collateral (CAA): 147 €„Adjusted surplus from Position 4 719Remaining exposure (E**): 134 €Capital requirement: 10,72 €
Risk weight Borrower (r): 100 %Exposure (E): 200 €Value of collateral (CA): 1.000 €Adjusted value of collateral (CAA): 1.000 €Remaining exposure (E**): 0 €Capital requirement: 0 €
Risk weight Borrower (r): 100 %Exposure (E): 1.000 €Value of collateral (CA): 886,90 €Adjusted value of collateral (CAA): 886,90 €Remaining exposure (E**): 113,10 €Capital requirement: 9,05 €
Risk weight Borrower (r): 100 %Exposure (E): 200 €Value of collateral (CA): 177,38 €Adjusted value of collateral (CAA): 177,38 €Remaining exposure (E**): 22,62 €Capital requirement: 1,81 €
65
Netting of Securities lending and Repo-Transactions (I)
If eligible Netting-agreements exist, net-positions can be calculated and haircuts will have to be applied on these net positions.
E* = max {0, [(∑ (E) - ∑ (C)) + ∑ (Es x Hs) + (∑(Efx) x Hfx)]}
E* = Exposure after nettingE = Original ExposureC = Market Value of CollateralEs = Amount of Net position in a given securityHs = Haircut applicable to EsEfx = Net-FX positionHfx = Haircut applicable to Efxr = Risk weight of borrower
RWA = r x E*
E* = max {0, [(∑ E - ∑ C) +VaR]}Alternatively:
66
E =
Netting of Repos and reverse Repos (II) -case
Bank A with Bank B (Rating A, => 50 %)The following transaction:
= security = 1.000 €
= Cash = 1.000 €
Bank A Bank BNr. 1
Bank A Bank BNr. 2
Hs = 10,6 %
E* = max {0, [(∑ (E) - ∑ (C)) + ∑ (Es x Hs) + (∑(Efx) x Hfx)]}
C =
C = = security = 600 €
= Cash = 600 €E =
Es = 1.000 € - 600 € = 400 €
Efx = 0 u. Hfx = 0
RWA = 42,4 € x 50 %= 21,2 €
Type Amount in EUR Securities underlying
Repo 1.000 share BMW
Reverse Repo 600 share BMW
Nr.
1
2
Haircut1
10,6 %
10,6 %
1transaction duration 5 days, daily margin call
(∑ (E) - ∑ (C)) = 0
E* = 400 € x 10,6 % = 42,4 €
67
Netting Repo and securities lending (III)
Banks can make use of their own VaR models under specific qualitative and quantitative requirements
E* = Repo or securities lending after risk reductionE = Markt value ExposureC = value of received securityr = Risk weight debtor
Equation for unsecured exposure e.g. The risk weighted assets changes as follows:
E* = max {0, [(∑ E - ∑ C) +VaR]}
RWA = r x E*
68
Impact of maturity mismatch
0,00
20,00
40,00
60,00
80,00
100,00
120,00
7,00 6,50 6,00 5,00 5,00 4,50 4,00 3,50 3,00 2,50 2,00 1,50 1,00
Maturity of loan in years
Val
ue o
f col
late
ral (
Eur
o)
Loan €100, duration 7 years, collateral €100, duration 6 yearsAdjusted amount of collateral with maturity mismatch
Value of collateral (CP 3) Value of Collateral (final)
69
Conclusion: risk mitigation
• Method to calculate the effects is provided by supervision
• Optimal allocation of collateral on loans is complex
• Sophisticated requirements for collateral management systems
• Qualitative requirements on the management of collateral have tobe fulfilled
• Knowledge about the effect of credit risk mitigation on the capital charge is essential
70
Exercise 1
Please calculate the RWA for the following loans considering supervisory haircuts and maturity mismatches
• Cash loan of 1 Mio. € to corporate rated “A”. Remaining maturity 4 years. Collateral is Government bonds; market value 1 Mio. € (revaluation every 20 days) with remaining maturity of 4 years
• Cash loan of 1 Mio. € to corporate rated “A”. Remaining maturity 4 years. Collateral is Government bonds; market value 1 Mio. € (revaluation every 20 days) with remaining maturity of 3 years
• Cash loan of 1 Mio. € to corporate rated “A”. Remaining maturity 4 years. Collateral is Government bonds; market value 1 Mio. € (revaluation every 20 days) with remaining maturity of 2 years
• Cash loan of 1 Mio. € to corporate rated “A”. Remaining maturity 4 years. Collateral is Government bonds; market value 1 Mio. € (revaluation every 20 days) with remaining maturity of 10 weeks
1
2
3
71
Case 1 (no mismatch)
Case 2 (rem. Mat. 3 years)
1,000,000 x (1 – 0.0395) = 960,500
= 3.95 %20 + 19
10HC = 2% x
1. Exposure E: 1,000,000 €Haircut exposure: 0
2. Adjusted value of collateral: 960,500 €Market value of collateral: 1,000,000 €Haircut Collateral: 3.95 %Haircut Currency: 0
3. Adjusted value of collateral after maturity mismatch: 960,500 €
4. Remaining exposure value: 39,500 €
5. Risk weighted assets: 19,750 €Risk weight of borrower: 50 %
1,000,000 € - 960,500 € = 39,500 €
39,500 € x 50 % = 19,750 €
1. Exposure E: 1,000,000 €Haircut exposure: 0
2. Adjusted value of collateral: 960,500 €Market value of collateral: 1,000,000 €Haircut Collateral: 3.95 %Haircut Currency: 0
3. Adjusted value of collateral after maturity mismatch: 704,367 €
4. Remaining exposure value 295,633 €
5. Risk weighted assets : 147,816.50 €Risk weight of borrower : 50 %
Ca = 960,500 € x (2.75/3.75) = 704,367 €
1,000,000 € - 704,367 € = 295,633 €
295,633 € x 50 % = 147,816.50 €
= 3.95 %20 + 19
10HC = 2% x
Solution 1 (I)
72
Case 3 (rem. Mat. 2 years)
Case 4 (rem. Mat. 10 weeks)
No consideration of collateral. Riskweight of borrower = 50 %
Exposure E: 1,000,000 €Haircut exposure: 0
2. Adjusted value of collateral: 960,500 €Market value of collateral: 1,000,000 €Haircut Collateral: 3.95 %Haircut Currency: 0
3. Adjusted value of collateral after maturity mismatch: 448,233 €
4. Remaining exposure value: 551,767 €
5. Risk weighted assets: 275,883.5 €Risk weight of borrower: 50 %
Ca = 960,500 € x (1.75/3.75) = 448,233 €
1,000,000 € - 448,233 € = 551,767 €
551,767 € x 50 % = 275,883.5 €
1. Exposure E: 1,000,000 €Haircut exposure: 0
2. Adjusted value of collateral: 0 €Market value of collateral: 0 €Haircut Collateral: 0 %Haircut Currency: 0
3. Adjusted value of collateral after maturity mismatch: 0 €
4. Remaining exposure value: 1,000,000 €
5. Risk weighted assets: 500,000 €Risk weight of borrower:
= 3.95 %20 + 19
10HC = 2% x
Solution 1 (II)
73
Exercise 2
Please calculate the RWA for the following loans considering supervisory haircuts and maturity mismatches
• Cash loan of 1 Mio. € to corporate rated “A”. Remaining maturity 4 years. Completely protected with a total Return Swap of 1 Mio. € (counterpart is insurance rated “AA”) with remaining maturity of 4 years
• Cash loan of 1 Mio. € to corporate rated “A”. Remaining maturity 4 years. Completely protected with a total Return Swap of 1 Mio. € (counterpart is insurance rated “AA”) with remaining maturity of 3 years
• Cash loan of 1 Mio. € to corporate rated “A”. Remaining maturity 4 years. Completely protected with a total Return Swap of 1 Mio. € (counterpart is insurance rated “AA”) with remaining maturity of 2 years
• Cash loan of 1 Mio. € to corporate rated “A”. Remaining maturity 4 years. Completely protected with a total Return Swap of 1 Mio. € (counterpart is insurance rated “AA”) with remaining maturity of 10 weeks
1
2
74
1. Exposure E: 1,000,000 €Haircut Exposure: 0
2. Adjusted value of protection: 1,000,000 €Value of protection: 1,000,000 €Haircut for FX: 0 %
3. Value of guarantee after Maturity mismatch: 1,000,000 €
4. Risk weight guarantor 20%
6. Uncollateralised portion 0 €
5. Risk weight borrower 50%
5. Risk weighted assets total 200.000 €
1. Exposure E: 1.000.000 €Haircut Exposure: 0
2. Adjusted value of protection: 1.000.000 €value of protection: 1.000.000 €Haircut for FX: 0
3. Value of guarantee after Maturity mismatch: 733.333 €
4. Risk weight guarantor 20%
6. Uncollateralised portion 266.667 €
5. Risk weight borrower 50%
5. Risk weighted assets total 280,000 €
Ca = 1,000,000 € x (2.75/3.75) = 733,333 €
1,000,000 € - 733,333 € = 266,667 €
295,633 € x 50 % = 147,816,50 €
Case 1 (no mismatch)
Case 2 (rem. Mat. 3 years)
Solution 2 (I)
75
1. Exposure E: 1,000,000 €Haircut Exposure: 0
2. Adjusted value of protection: 1,000,000 €value of protection: 1,000,000 €Haircut for FX: 0
3. Value of guarantee after Maturity mismatch: 466,667 €
4. Risk weight guarantor 20%
6. Uncollateralised portion 533,333 €
5. Risk weight borrower 50%
5. Risk weighted assets total 360,000 €
1,000,000 € - 448,233 € = 551,767 €
551.767 € x 50 % = 275.883.5 €
1. Exposure E: 1.000.000 €Haircut Exposure: 0
2. Adjusted value of protection: 1.000.000 €value of protection: 1.000.000 €Haircut for FX: 0
3. Value of guarantee after Maturity mismatch: 0 €
4. Risk weight guarantor 20%
6. Uncollateralised portion 1.000.000 €
5. Risk weight borrower 50%
5. Risk weighted assets total 360,000 €
Case 3 (rem. Mat. 2 years)
Case 4 (rem. Mat. 10 weeks)
No consideration of collateral. Riskweight of borrower = 50 %
Solution 2 (II)
76
Exercise 3
Please calculate the Risk weighted Assets for the following loans collateralised with physical collateral
• Loan to a private individual of 500,000 € collateralised with physical collateral (private home) with total market value of 1,200,000 €
77
Case 2
1. Exposure 500,000 €
2. Risk weight of collateralised portion 35%
3. Risk weighted assets total 175,000 €
Solution 3
78
Agenda
1. Introduction to Basle II• Scope of Application• Basel I and II• Overview of Minimum Capital Requirements• Standardised versus IRB Approach• Partial Use
2. Minimum Capital Requirements for Credit Risk: Standardised Approach• Exposure Classes• External Ratings and Risk Weights• Credit Risk Mitigation
• Guarantees and Credit Derivatives• Collateral
• Examples
3. Questions and Answers