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The New Basel Capital Accord
Darryll Hendricks
Senior Vice President
Federal Reserve Bank of New York
February 2, 2001
(Second Consultative Package)
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Major Basel Objectives• Better align regulatory capital to underlying risk
and provide incentives for banks to enhance their risk management capabilities
• Capital adequacy more than compliance with required minimum ratios -- also encompasses supervisory review and market discipline
• Meaningful minimum prudential requirements and international consistency
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Basel Committee Effort
• Release of first Consultative Paper (June 1999) – Significant work has continued – More than 200 comments received from a variety of
sources (financial institutions, supervisors, etc.)
• Internal ratings-based (IRB) approach to capital adequacy has taken on a greater role in the Committee’s thinking
• Strong support for three pillar framework and increased risk differentiation
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Second Consultative Package
• Released January 16, 2001
• Comprises three parts: – Overview Paper – New Basel Accord or “Rules” document
– Supporting Technical Documents
• Comment period ends May 31, 2001
• Implementation in 2004
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Revisions to capital measures
• Definition of capital to remain unchanged
• Modifications to denominator of risk-based capital ratios
Total Capital
(Credit risk + Market risk + Operational risk)
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Scope of Application of New Accord
• Continues to apply to internationally-active banks on a consolidated basis
• Explicit application to consolidated BHCs that are parents of banking groups
• Securities activities generally considered banking activities -- full consolidation
• Insurance activities not considered banking activities -- general rule to deduct investments and de-consolidate assets
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Pillar 1: Minimum Capital
• Two approaches to credit risk: – Revised Standardized approach – Internal ratings-based (IRB) approaches
• Explicit capital charge for operational risk– Basic indicator, standardized and internal
measurement approaches
• 1996 Market Risk Amendment to remain largely unchanged
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Approaches to Credit Risk
• Revised Standardized Approach
– Improved risk sensitivity compared to 1988 Accord
• IRB Approaches: Foundation & Advanced
– Reliance on banks’ own internal risk ratings
– Considerably more risk sensitive
– Accompanied by minimum standards and disclosure requirements
– Allow for evolution over time
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Revised Standardized Approach
• Similar to 1988 Accord in that risk-weights determined by category of borrower (sovereign, bank, corporate)
• Risk weights now based on external credit ratings with unrated credits assigned to 100% risk bucket
• Elements of improved risk sensitivity – Elimination of OECD club preference– Greater differentiation for corporate credits– Introduction of higher risk categories (150%)– Option to allow higher risk weights for equities
• Targeted at banks desiring simplified capital framework
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Key elements of IRB Approaches
• Four variables: – Probability of default (PD) of borrower over one-year
time horizon
– Loss given default (LGD)
– Maturity (M)
– Exposure at default (EAD)
• Risk weights will be function of these four variables and type of exposure (e.g., corporate, retail)
• “Foundation” and “Advanced” IRB approaches
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Foundation IRB Approach • Banks to develop own estimates of PD for each
rating grade– Rigorous minimum standards and disclosure
requirements for entry and ongoing use
• LGD estimates based on supervisory values– 50% for senior unsecured claims– 75% for subordinated claims
• EAD estimates based on supervisory values– 75% for irrevocable undrawn commitments
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Foundation IRB Approach (cont.)
• Likely no maturity distinction – Assume single average maturity (e.g., 3 years)
• Standardized treatment of credit risk mitigation techniques (H & w framework) to apply
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Advanced IRB Approach • Banks’ own estimates of PD, LGD, EAD
– Subject to rigorous but attainable standards that reflect the need for long data series
• Maturity adjustments to be incorporated– Additional work to be conducted
• Greater flexibility in the treatment of collateral, guarantees and credit derivatives
• Floor equal to 90% of simplified foundation IRB charges imposed for first two years
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Example Risk Weights under Foundation IRB Approach
• Risk weights for Advanced IRB approach scaled up and down to reflect maturity of the exposure
• Granularity adjustment to result in increased capital charges for concentrated portfolios of exposures
Risk Weights for Corporate Exposures
PD(in basispoints)
3 bpAAA/AA
5 bpA
20 bpBBB
100 bp 140 bpBB
700 bpB
RW 14 19 45 125 154 400
* Risk weights based on a 50% LGD and an average maturity of 3 years.
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IRB Absolute Capital
• How much capital is needed to cover the risk?– How conservative do minimum requirements need to be?
• How will the new capital adequacy framework compare to the current Accord?– What is the impact on an average bank?
• What incentives should be provided to move toward the more advanced approaches?
• Second CP starting point for dialogue with industry– Survey evidence to inform IRB calibration
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IRB Approaches: Ongoing Work
• Retail exposures
• Project finance exposures
• Treatment of equities
• Slope of maturity adjustment
• Absolute capital
• Asset securitization
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Credit Risk Mitigation• Expansion of regulatory treatment for collateral,
guarantees, credit derivatives and on-balance sheet netting
• Similar rules-based treatment in standardized and foundation IRB approaches– Simple approach (substitution based)
– Comprehensive approach (captures residual risks)
• Recognition of internal assessments under advanced IRB approach
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Credit Risk Mitigation (cont.)
• Broader range of collateral accepted, including listed equities and all investment-grade debt
– Value of collateral subject to haircuts (H) and a floor (w) on the total capital reduction
– Domestic repo market transactions carved out from capital requirements
• Expanded recognition of guarantors (sovereigns, banks, corporates rated A or better)
• Credit derivatives explicitly addressed
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Asset Securitization • Proposals for treatment of explicit risks in
standardized and IRB approaches
– Deduction of first loss protection held by bank
• Committee considering treatment of implicit risks
– Potential for securitized assets to return to banks’ balance sheet
• Future work plan
– IRB treatment, synthetic securitizations, implicit and other residual risks, etc.
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Operational Risk
• Narrowed focus to treatment of operational risk
• A range of approaches outlined– Basic indicator approach (measure of total activity)
– Standardized approach (business line)
– Internal measurement approach
• Eligibility to use approaches tied to compliance with measurement and control criteria
• Consultation with industry to continue
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Interest Rate Risk
• Interest rate risk in the banking book to be assessed through supervisory review (Pillar 2)
• Guidance provided for “outlier” banks -- those for which economic value of capital declines by more than 20% from a 200 bp interest rate shock
• Supervisory options include asking outlier banks to reduce risk, hold a specific amount of capital or some combination thereof
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Pillar 2: Supervisory Review
• Consultative Package outlines four principles for supervisory review:
– Each bank should assess its internal capital adequacy in light of its risk profile
– Supervisors should review internal assessments
– Recommendation that banks hold capital above regulatory minimums
– Supervisors should intervene at an early stage
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Pillar 3: Market Discipline
• Promote market discipline through greater transparency and improved public disclosure
• Disclosure “recommendations” and “requirements” particularly important given increased reliance on internal assessments
• IRB disclosure requirements include:
– PDs, LGDs, and EADs within portfolios– Composition and assessment of risk– Performance of internal assessments
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Pillar 3: Market Discipline
• “Strong” recommended disclosures put forth:– Scope of application – Components of regulatory capital (Tier 1, Tier 2, etc.) – Risk exposures and assessments (credit, market and
operational risk) – Capital adequacy disclosures (risk-based capital ratios)
• Appropriate level of data disaggregation subject to further work