Taiwan Ratings Corporation

Richard Shih, Chairman

May 15, 2004

The Impact of Basel II on Credit Rating

Agencies & Financial Institutions

This presentation will evaluate the

impact of the Third Consultative

Paper (CP3) of the New Basel

Capital Accord on corporations

using external credit assessment

and on financial institutions.

I. Impact of External Credit Assessment on the Financial Market

Credit assessmentof Sovereign

AAAto AA-

A+ toA-

BBB+to

BBB-BB+to B-

BelowB- Unrated

Risk weight underOption 1 20% 50% 100% 100% 150% 100%

Option 1

Credit assessmentof Banks

AAAto AA-

A+ toA-

BBB+to

BBB-BB+to B-

BelowB- Unrated

Risk weight underOption 2 20% 50% 50% 100% 150% 50%Risk weight forshort-term claimsunder option 2 20% 20% 20% 50% 150% 20%

Option 2

1. Measures for calculating bank credit risk by a standardized approach are listed in Pa-34 to 38 of CP3.

2. According to Pa-34 and 35 of CP3, no claim on an unrated bank may receive a risk weigh less than that applied to claims on its sovereign of incorporation (PA 34). Banks have two options. Under the first option, all banks incorporated in a given country will be assigned a risk weight one category less favorable than that assigned to claims on the sovereign of that country (Pa-35).

3. Application in Practice

(1) In option 1, which rating should apply if ratings assigned by two ECAIs (External Credit Assessment Institutions), both recognized by national supervisors, are different? Should multiple assessment provisions be applied, that is, should the higher rating be applied? (Pa-66)

(2) If there are three or more different ratings from three ECAIs, should Pa-67 apply? Should priority be given to the two lowest risk weight, with the higher of the two applied?

II. Corporates With Poor Credit May Be Unwilling to be Rated

Creditassessment

AAA toAA- A+ to A-

BBB+to BB-

BelowBB- Unrated

Risk weight 20% 50% 100% 150% 100%

1. It is disputable that the standard risk weight for

unrated claims on corporates will be 100%. As

the 100% risk weight is lower than the 150% risk

weight for corporates rated BB- or below, this

may make corporates with poor credit unwilling

to be rated, or keep the rating confidential to

reduce financing costs. Banks may prefer to

extend loans to unrated corporates to reduce

operating costs (Pa-40).

2. Corporates with poor credit will choose banks that adopt the standardized approach. Such an approach may harm banks’asset quality and be unfavorable to the banks’long-term operations.

3. Banks adopting the standardized approach and Internal Ratings-based (IRB) approach will be separated in the market. In the long run, banks adopting the standardized approach will gradually switch to IRB. In the short term, corporates with poor credit will choose the standardized appoach.

4. Proposals by a Joint-Research Team on UnratedRisk Weight

(1) The standardized approach will apply to unrated corporates and the risk weight will remain 100%. This approach is simple and may serve as an interim approach before conversion to IRB approach is completed.

(2) The risk weight of unrated corporates is likely to increase year by year year, thereby improving banking risk management sensitivity.

The first phase (1) is easy to implement, and more practical; the second phase (2) will depend on more research, simulation and the JCIC (Joint Credit Information Center) databank.

III. The Mapping Process

1. According to CP3, supervisors will assign ECAI

assessment to the risk weights available under

the standardised risk weighting framework. The

mapping processing should cover all risk

weights (Pa-62).

2 . When conducting such a mapping process,

supervisors should consider the size and scope

of the issuers that each ECAI covers, the range

of the assessments assigned and the definition

of default. Annex 2 is provided as guidance (Pa-

63).

3. A research team calculated the risk weights of corporates assigned ratings by TRC who were extended loans by banks. The results showed that the capital requirement of state-owned banks is reduced, while the capital adequacy ratio of corporates increased by an average 0.23%.

4. JCIC has established a national credit information databank. Supervisors may make use of the information from rating agencies, as well as information from JCIC, for an extensive simulation to obtain a more practical mapping process.