SAMPLE COMPARISON BETWEEN BASEL I AND BASEL 2 CAPITAL FOR CORPORATE ASSET CLASS CREDIT RISK

For calculating capital, we need a set of default probabilities per rating class. The comparison is meaningful under the same framework. Capital charge is calculated with a risk weight of 100% for Basel 1 and without any credit risk mitigation effect.

Figure 20.1 provides the comparison. The bars are the capital charges. The x-axis shows the corresponding ratings. The default probabilities are implicit in the graph, since they map to ratings for the calculation to be feasible. We used a sample mapping of default probabilities to the detailed rating scale. The sample mapping of default probabilities to external ratings is provided in Table 20.4. The methodology for obtaining such mapping is expanded in Chapters 40 and 41.

Comparison of capital charges per rating class: Basel I, Basel 2 standard, Basel 2 advanced approach

FIGURE 20.1 Comparison of capital charges per rating class: Basel I, Basel 2 standard, Basel 2 advanced approach

SPECIALIZED LENDING

For SL categories (PF, OF, CF, IPRE, and HVCRE) banks may estimate the DP under the corporate foundation approach, or they use the "supervisory slotting criteria approach." In the second method, they map their internal risk grades to five supervisory categories. Each supervisory category is associated with a specific risk weight. A sample of supervisory risk weights is shown in Table 20.5.

SECURITIZATIONS

Securitization exposures are treated separately with a hierarchy of three approaches.

• The rating-based approach (RBA) must be applied to securitization exposures that are rated, or where a rating can be inferred.

TABLE 20.4 Sample mapping of default probabilities to ratings

Sample mapping of default probabilities to ratings

TABLE 20.5 Supervisory categories and risk weights for SL exposures

Supervisory categories and risk weights for SL exposures

• Where an external or an inferred rating is not available, either the supervisory formula (SF) or the internal assessment approach (IAA) must be applied.

Securitization exposures to which none of these approaches can be applied must be deducted from capital.

The accord imposes the "clean break" principle through which the non-recourse sale of assets should be unambiguous, limiting the temptation of banks to support sponsored structures for reputation motives (reputation risk[1]).

The accord assigns risk weights in line with the seniority of structured notes issued by such structures. The credit enhancement note concentrates a large fraction of the risk of the pool of securitized assets. Other issues with securitizations relate to operational risk. Revolving securitizations, with early amortization features, or liquidity lines provided to structures (commitments to provide liquidity for funding the structure under certain conditions), generate some residual risks. There is a standard capital loading for such residual risk.

  • [1] Reputation risk is the risk of adverse perception of the sponsoring bank if a structure explicitly related to the bank suffers from credit risk deterioration or from a default event.
 
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