Standardized Basel III Credit Risk Assessment – What You Need to Know

Basel III the updates take a more sensitive approach to the calculation of risk weights and capital requirements. Paul Whitmore, Global Head of Counterparty Risk Solutions at Fitch Solutions, Explains How Credit Risk Professionals Can Prepare

Paul Whitmore, Fitch Solutions

Banks have until January 2023 to familiarize themselves with the new standardized credit risk assessment (SCRA) approach introduced under Basel III updates. This new methodology for assigning risk weights to unrated bank exposures will undoubtedly increase the data management burden for many banks. In addition to bringing together the minimum capital requirements and capital buffer requirements of all jurisdictions in which a bank has unrated exposures, banks will need to sift through the annual reports of individual counterparties.

The extent of the data management effort will depend on the size and geographic distribution of a bank’s unrated portfolio, but is likely to be time consuming and resource intensive. To help banks meet this challenge, Paul Whitmore, Global Head of Counterparty Risk Solutions at Fitch Solutions, explores the main elements of this new approach.

What types of banks will be affected by the new SCRA approach?

Paul Whitmore: All internationally active banks located in jurisdictions that adhere to the Basel rules will be affected and, in particular, those with exposures to unrated banks. Many large banks are currently benefiting from the use of model-based approaches, which can lead to reduced risk weights and capital requirements. However, with the new regulation, the focus will be on the calculation of risk-weighted assets (RWAs) using the unmodeled standard approach.

In addition, banks incorporated in countries such as the we that do not allow the use of external ratings for regulatory purposes might need this data to calculate their unrated and foreign bank exposures. It will depend on the form of the final rules in their individual jurisdictions.

What challenges are banks facing with the new SCRA methodology?

Paul Whitmore: The main challenges will relate to the collection and maintenance of data from global banking jurisdictions. This was certainly the case for the clients that Fitch Solutions has integrated so far. Retrieving minimum regulatory requirements from monitoring websites can be difficult – the information is often difficult to locate and may be in a different language.

In addition to keeping this data, banks may encounter problems when using it to process and calculate RWAs. For example, there may be differences in jurisdictional capital buffer requirements, some being additive and others the greater of two amounts.

What is the objective of the exit floor that will be phased in under this approach?

Paul Whitmore: This will create a more level playing field between banks that use sophisticated internal models and those that use the standardized approach. It will also reduce the excessive variability of RWAs calculated using the banks’ model approaches.

Historically, large banks typically used internal model estimates, and these could generate very low risk weights, reducing their minimum capital requirements. Under the new regulations, these modeled capital charges will have to be at least 75% of the total RWAs calculated using the standardized approach. This could lead to an increase in certain risk weights within the framework of the SCRA approach.

How does the data required under the SCRA approach the benefit banks?

Paul Whitmore: Fixed risk weights are currently applied to unrated banks under the standardized approach, requiring more capital than typical investment grade credit ratings. Under the new regime, provided that the SCRA can be used, risk weights may fall, reducing banks’ capital requirements.

It is because the SCRA is more granular than the old standard unrated approach. Instead of a single fixed risk weight that sees all unrated banks treated the same by regulators, SCRA has three different compartments for unrated banks. This could therefore lead to a reduction in risk weights from 100% to 30% in some cases.

What should potential users look for in a SCRA data solution?

Paul Whitmore: For those looking for an outside solution, finding a vendor with a solid track record of collecting and maintaining high volumes of complete and standardized data should be a top priority. Doing this in areas where information is difficult to find and interpret adds another layer of difficulty, and therefore previous experience of this would add more value.

It’s also important to check the team credentials behind the numbers. Efficient sourcing of this data requires professionally trained analysts and data specialists with the expertise and language skills to analyze banking and supervisory records from jurisdictions around the world.

Where should banks now be to ensure they are fully prepared for the January 2023 implementation?

Paul Whitmore: Many banks took advantage of the additional 12 months granted in March 2020 by the Basel Committee on Banking Supervision due to the Covid-19 pandemic. Most are only assessing the implications of reforms now that draft rules are starting to be published by regulators.

If they haven’t already, we would expect banks to conduct quantitative impact studies to understand how the reforms will affect their capital calculations. They will review all permutations of their models based on Internal Ratings, Credit Ratings for the External Credit Risk Assessment Approach, and their current datasets to help them adhere to the SCRA guidelines.

It should be remembered that the larger the bank – or the wider its geographic reach – the greater the task. For banks of all sizes, however, preparing for this change should be a priority.

Download the complete Basel IIISCRA data briefing document

Download this information document to learn more about the compliance and data challenges involved, and why your business should start preparations now

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