Recent BIS Reforms: Implications for RWA modelling

The latest BIS reforms were announced in December 2017, and are mostly expected to be in place by 2022.

These will:

• Remove the option to use the Advanced IRB (A-IRB) approach for certain asset classes
• Adopt input floors for probability of default (PD) and loss given default (LGD)
• Provide greater specification on parameter estimation to reduce risk-weighted asset (RWA) variability

Removal of A-IRB approaches

Corporates with consolidated revenues > €500m, banks and financial institutions will no longer be eligible for A-IRB from 2022, so at a minimum they will have to use standardised LGD estimates for these exposures. These asset classes will be treated using either (1) Foundation IRB (F-IRB) approach (i.e. banks can still use their own PD estimates) or (2) the Standardised approach. The reforms also propose to shift all equity exposure towards the Standardised approach.

Specification of input floors

New minimum parameter estimates will be applied to probability of default (PD), loss given default (LGD) and exposure at default (EAD) estimates.

• PD: Corporates, banks, mortgages, QRRE transactors and other retail will have a 5bp floor, equivalent to a CBC of a+.  QRRE revolvers will have a 10bp floor, equivalent to a CBC of a-
• Unsecured LGD: Corporates will have an unsecured floor of 25%
• Secured LGD: depends on collateral type: Financials 0%, Receivables 10%, Commercial & Residential real estate 10% & Other Physical 15%
• EAD: EAD is subject to a floor of the sum of the on-balance sheet exposures using the applicable Credit Conversion Factor in the Standardised approach

Additional Enhancements

Adjustments were also made to the supervisory specified parameters including:

• Increasing haircuts and reducing the LGD parameter for non-financial collateral exposures
• Reducing the LGD parameter for unsecured non-financial corporates exposures from 45% to 40%
• A revised output floor where the banks’ risk-weighted assets must be calculated as the higher of total risk-weighted assets calculated and 72.5% of the total risk-weighted assets calculated using only the Standardised approach

Related Developments in Credit Benchmark data

The Credit Benchmark consortium was originally launched to give banks greater insight into credit risk with respect to regulatory requirements. However, the outputs are increasingly being used in a broader set of use cases and there are situations where good risk management needs to go beyond the regulatory requirements. To reflect this, Credit Benchmark typically collect data that reflects pre-regulatory overrides for both PDs and LGDs.  The overall aim is to maximise the value of credit risk estimates in maintaining and improving high standards across credit risk management in all of its forms.