The Credit Risk the Standardized Approach.pdf

Credit Risk:
the Standardized Approach
Regulation (EU) No 575/2013
of 26 June 2013
Banking: Financial and Risk Management – A.Y. 2022/2023

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Basel III first pillar: own funds requirements for institutions
Credit Risk
• Institutions shall at all times satisfy the following own funds requirements:
a) a Common Equity Tier 1 capital ratio of 4,5%;
b) a Tier 1 capital ratio of 6%;
c) a total capital ratio of 8%
expressed as a percentage of the total risk exposure amount.
Total risk exposure amount shall be calculated as the sum of:
- the risk weighted exposure amounts for credit risk in respect of all business
activities of an insititution excluding risk weighted exposure amounts from the
trading book business of the institution;
- the own funds requirements for the trading-book business for the following
risks: position risk, large exposures exceeding the limits, foreign-exchange risk,
settlement risk, commodities risk;
- the own funds requirements for the operational risk.
The Institutions shall multiply the own funds requirements by 12,5.
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Basel III first pillar: minimum capital requirements
Credit Risk
• Banks may choose between 2 methodologies for calculating their capital
requirement for credit risk:
– the standardized approach: it is a development of the system established
in the 1988 Capital Accord;
– the IRB approach: it is broken down into a:
• foundation approach and;
• advanced approach.
• The sensitivity of the standardized approach to credit risk is enhanced by
means of increased segmentation of exposures and the use of ratings
issued by export credit agencies (ECAs) or specialized external credit
assessment institutions (ECAIs) recognised for this purpose by the supervisory
authorities.
• There is a more favourable regulatory treatment of retail exposures, which
captures the effective risk of this portfolio, and it is especially important for
economies in which small and medium-sized enterprises are a major presence.
• The regulations also define past-due exposures, which should prompt banks to
improve their loan management practices.

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The Standardized Approach
• The application of the basic method for calculating the capital
requirement for credit risk entails:
1. the assignment of exposures to 17 different classes based on:
• the nature of the counterparty or
• the technical characteristics of the transaction or
• the manner in which it is carried out.
The exposure classes are:
• central governments and central banks;
• institutions;
• regional governments and local authorities
• public sector entities;
• multilateral development banks;
• international organizations;
• corporates;
• retail exposures;
• institutions and corporates with a
short-term credit assessment;
• collective investment undertakings (CIUs);
• securitization positions;
• exposures secured by real estate property;
• exposures in the form of covered bonds;
• exposures in default;
• items associated with particular high-risk;
• equity exposures
• other exposures.

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2. The assignment of diversified risk weights to each portfolio shall be
possibly based on credit assessments issued by a third party
recognized by the Bank of Italy (ECAI) or by an export credit agency
(ECA) recognized by the Bank of Italy or by a competent authority of
another Member State.
Specifically:
– the risk weights for central governments and central banks shall be
based on the ratings assigned by ECAIs or ECAs to the individual
countries, unless it shall be assigned a 100% risk weight.
– The retail portfolio shall comprise exposures to individuals and small and
medium-sized enterprises meeting specific requirements. Such exposures
shall be assigned a risk weight of 75%.
– Exposures secured by real estate shall be assigned to a specific class.
The exposures shall be assigned a risk weight of 35% or 50%,
depending on whether the property is residential or commercial,
respectively.

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• A risk weight of 100% shall be assigned to exposures in classes
for which risk weights based on external ratings may be used
where one of the following conditions obtains:
a) the bank does not intend to use a rating assigned by an
ECAI/ECA;
b) where the bank uses ratings, no ECAI/ECA selected by the
bank has issued a rating for the exposure. The bank may
benefit from the use of credit risk mitigation techniques.

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Risk Weights for Exposures
1. Exposures to central governments and central banks: they shall
be assigned risk weights based on the rating assigned by an
ECAI/ECAs in accordance with:
Credit quality step
(ECAIs)
Score
(ECAs or SACE S.p.A.)
Risk weight
1 0-1 0%
2 2 20%
3 3 50%
4 and 5 4-6 100%
6 7 150%
Where a bank does not use ratings issued by an ECAI/ECAS or the
nominated ECAIs/ECAs do not assign a rating, as an alternative, it shall
apply a 100% risk weight.

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1. Exposures to central governments and central banks
• Exposures to the central governments and central banks of
Member States denominated and funded in the domestic
currency shall receive a risk weight of 0% (preferential risk
weight).
• Where the supervisory authority of a non-Member State assigns
a risk weight that is lower than that indicated to exposures to
their central government or central bank denominated and
funded in the domestic currency, banks shall assign the same
risk weight to such exposures.
• Exposures to the Italian State shall comprise exposures to
constitutional bodies, ministries, the Bank of Italy. Exposures to
the European Central Bank shall be assigned a 0% risk
weight.

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2. Exposures to rated institutions
• Exposures to rated institutions with a residual maturity of more than
three months for which a credit assessment by a nominated ECAI is
available shall be assigned a risk weight according to the table:
Credit quality step
(ECAIs)
Risk weight
1 20%
2 50%
3 50%
4 and 5 100%
6 150%

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2. Exposures to rated institutions
• Exposures to rated institutions of up to three months residual maturity
for which a credit assessment by a nominated ECAI is available shall be
assigned a risk weight according to the table:
Credit quality step
(ECAIs)
Risk weight
1 20%
2 20%
3 20%
4 and 5 50%
6 150%

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2. Exposures to unrated institutions
• Exposures to institutions for which a credit assessment by a nominated
ECAI is not available shall be assigned a risk weight according to the
credit quality step to which exposures to the central government of the
jurisdiction in which the institution is incorporated are assigned in
accordance with the table:
Credit quality step to
which central
government is
assigned
Risk weight
1 20%
2 50%
3 100%
4 and 5 100%
6 150%

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2. Exposures to unrated institutions
• For exposures to unrated institutions incorporated in countries where
the central government is unrated, the risk weight shall be 100%.
• For exposures to unrated institutions with an original effective maturity
of three months or less, the risk weight shall be 20%.

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2. Exposures to institutions
• Exposures to supervised institutions connected with the reserve
requirement established by the ECB or another central bank (indirect
compliance with reserve requirements) shall be treated as exposures
to central banks. Such preferential treatment shall apply provided
that:
– the reserves are held in accordance with Regulation;
– in the event of the bankruptcy or the insolvency of the supervised
institution that holds the reserves, the reserves are fully repaid to
the supervised institution and are not made available to meet other
liabilities of the defaulting institution.
• Shareholdings and subordinated capital instruments issued by
institutions shall be assigned a risk weight based on the exposure
class to which the exposure is assigned where they are not
deducted from supervisory capital.
• Italian branches of foreign banks and foreign branches of Italian banks
shall be assigned the risk weight applicable to the parent bank.

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2. Exposures to supervised institutions: special risk weights
• The exposures of a bank to companies belonging to the same banking
group established in Italy shall be risk weighted at 0% in calculating
individual capital requirements, provided that the following conditions
are met:
- The exposures aren’t CET1, Additional Tier 1, Tier 2;
– the counterparty is included in the same consolidation as the
institution on a full basis;
– The counterparty is subject to the same risk evaluation,
measurement and control procedures at the institution;
– The counterparty is established in the same Member State as the
institution;
– There is no current or foreseen material practical or legal
impediment to the prompt transfer of own funds or repayment of
liabilities from the counterparty to the institution.
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2. Exposures to institutions: special risk weights
• Exposures between Italian banks belonging to the same institutional
protection system shall be risk weighted at 0% in calculating the
individual capital requirements, provided that they meet the following
requirements:
– The exposures aren’t CET1, Additional Tier 1, Tier 2;
– There is no current or foreseen material practical or legal impediment to
the prompt transfer of own funds or repayment of liabilities from the
counterparty to the institution;
– The arrangements ensure that the institutional protection scheme is able to
grant support necessary under its commitment from funds readily available
to it;
– The institutional protection scheme disposes of suitable and uniformly
stipulated systems for the monitoring and classification of risks, which
gives a complete overview of the risk situations of all the individual
members and the institutional protection scheme as a whole;
– The institutional protection scheme conducts its own risk review which is
communicated to the individual members;
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2. Exposures to institutions: special risk weights
- The institutional protection scheme publishes on an annual basis, a
consolidated report comprising the balance sheet, the profit and loss
account, the situation report concerning the institutional protection
scheme as a whole;
- Members are obliged to give advance notice of at least 24 months if
they wish to end the institutional protection scheme;
- The scheme shall be based on a broad membership of credit
institutions of a predominantly homogeneous profile.
• The recognition of the 0% risk weight shall be subject to the
verification by the central bank of the adequacy of the systems and
methodologies and compliance with all other requirements under
applicable law.
• The Bank of Italy shall regularly verify the adequacy of the systems
and methodologies and shall revoke recognition of the 0% risk weight
should it discover non-compliance with one of the requirements
provided for.
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3. Exposures to regional governments
and local authorities
• Exposures to regional governments and local authorities shall be risk-weighted
as exposures to institutions unless they are treated as exposures to central
government.
• The Bank of Italy may allow regional governments and local authorities to be
receive the same risk weight as the central government in whose jurisdiction
they are established where there is no significant difference in the risk of the
exposures because of the revenue-raising powers of the regional governments
and local authorities and the existence of specific institutional arrangements
the effect of which is to reduce their risk of default.
• Where a third country applies the same risk weight for the central government
to regional governments and local authorities established in its jurisdiction,
banks may use the same risk weight.
• Exposures to r.g. and l.a. of the Member States that are not referred to in
points 2 and 3 and are denominated and funded in the domestic currency of
the r.g. and l.a. shall be assigned a risk weight of 20%.

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4. Exposures to public sector entities
• Exposures to public sector entities for which a credit assessment by a
nominated ECAI is not available shall be assigned a risk weight
according to the credit quality step to which exposures to the central
government of the jurisdiction in which the public sector entity is
incorporated are assigned in accordance with the table:
Credit quality step to
which central
government is
assigned
Risk weight
1 20%
2 50%
3 100%
4 and 5 100%
6 150%

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4. Exposures to public sector entities
• Exposures to public sector entities incorporated in countries where the central
government is unrated, the risk weight shall be 100%.
• Exposures to public sector entities for which a credit assessment by a
nominated ECAI is available shall be treated in accordance with exposures to
rated institutions.
• For exposures to public sector entities with an original maturity of three
months or less, the risk weight shall be 20%.
• The Bank of Italy may establish that the risk weight of the central government,
regional government or local autority in whose jurisdiction a public sector entity
is established shall apply to the public sector entity provided that an
appropriate guarantee by the central government, regional government or local
authority exists.
• Exposures to a public sector entity established in a Member State or G-10
country which applies the risk weights envisaged for supervised institutions or
the central government to public sector entities shall be risk weighted using the
same risk weights applied in the home country in which the entity is
established. The Bank of Italy may extend this treatment to public sector
entities established in other countries with a system of supervision equivalent
to that in Italy.

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5. Exposures to multilateral development banks and
6. Exposures to international organizations
• Exposures to multilateral development banks (MDB) that are not rated shall be
treated in the same manner as exposures to institutions.
• The class “6.” includes only exposures to the European Community, the Bank
for International Settlements, the International Monetary Fund, the European
Financial Stability Facility, the European Stability Mechanism, an international
financial institution established by two or more Member State which has the
purpose to mobilise funding and provide financial assistance to the benefit of
its member that are experiencing or threatened by severe financing problems
risk-weighted at 0%.
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5. Exposures to multilateral development banks
• A 0% risk weight shall apply to exposures to the following MDBs, regardless
of any external credit rating assigned:
– International Bank for Reconstruction and Development (IBRD);
– International Finance Corporation;
– Inter-American Development Bank;
– Asian Development Bank;
– African Development Bank;
– Council of Europe Development Bank;
– Nordic Investment Bank;
– Caribbean Development Bank;
– European Bank for Reconstruction and Development (EBRD);
– European Investment Bank (EIB);
– European Investment Fund (EIF). A risk weight of 20% shall be
assigned to the portion of unpaid capital subscribed to the European
Investment Fund;
– Multilateral Investment Guarantee Agency;
– International Finance Facility for Immunisation
– Islamic Development Bank.

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7. Exposures to corporates
• This class includes exposures to corporates and small and medium-
sized enterprises that cannot be classified under retail exposures.
• Exposures for which a credit assessment by a nominated ECAI is available shall
be assigned a risk weight according to the table .
• Where the bank does not use credit assessments issued by ECAIs or no rating
has been assigned, a 100% risk weight shall be applied.
• The risk weight of such undertakings may not be more favourable than that
assigned to the central government in whose jurisdiction the undertaking is
established.
Credit quality step (ECAIs) Risk weight
1 20%
2 50%
3 and 4 100%
5 and 6 150%
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8. Retail Exposures
• Exposures that comply with the following criteria shall be assigned a risk
weight of 75%:
a) the exposure shall be either to a natural person or persons, or to a small or
medium-sized enterprise (SME);
b) the exposure shall be one of a significant number of exposures with similar
characteristics such that the risks associated with such lending are sustantially
reduced;
c) the total amount owed to the institution and parent undertakings and its
subsidiaries, including any exposure in default, by the obligor client or group of
connected clients, but excluding exposures fully and completely secured on
residential property collateral that have been assigned to this exposure class,
shall not, to the knowledge of the institution, exceed EUR 1 million.
• Securities shall not be eligible for the retail exposures class.

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9. Exposures to institutions and corporates
with a short-term credit assessment
• Exposures to institutions and to corporates for which a short-term
credit assessment by a nominated ECAI is available shall be assigned a
risk weight according to the table:
1 20%
2 50%
3 100%
from 4 to 6 150%

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10. Exposures in the form of units or shares in collective
investment undertakings (CIUs)
• Exposures in the form of units or shares in CIUs shall be assigned a
risk weight of 100% unless the institution applies the credit risk
assessment method, or the look-through approach or the average risk
weight approach.
• Credit risk assessment method
• Exposures in the form of CIUs shall be risk weighted on the basis of
the credit assessment assigned by an ECAI:
1 20%
2 50%
3 and 4 100%
5 and 6 150%

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10. Exposures to collective investment undertakings (CIUs)
• The look-through approach
• When the bank is aware of the underlying exposures of a CIU, it may look
through to those underlying exposures in order to calculate an average risk
weight for its exposures in the form of units or shares in the CIUs. Where an
underlying exposure of the CIU is itself an exposure in the form of shares in
another CIU, the bank may look through to the underlying exposures of that
other CIU.
• The average risk weight approach
• Where the bank is not aware of the underlying exposures of a CIU but may
obtain information on the maximum investment limits in the various exposure
classes established under the fund’s mandate, it may apply an average risk
weight calculated on the basis of such information.

10. Exposures to collective investment undertakings
(CIUs)
• In this case the risk weight shall be calculated through the progressive
application, in descending order, of the risk weights of the exposure
classes attracting the highest capital requirement to the maximum
investment allowed under the mandate of the CIUs in each class, until
the maximum total investment limit is reached.
• For example, if the CIU’s rules permit it to invest up to 20% of its
assets in shares of undertakings with a 100% risk weight and the
remaining amount in government securities risk weighted at 20%, the
average risk weight would be: 20%x100% + 80%x20% = 36%
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10. Exposures to collective investment undertakings (CIUs):
the average risk weight method
• Banks may apply the look-through approach or the average risk weight
of a CIU provided that the following eligibility criteria are met:
– the CIU is managed by a company which is subject to supervision in a
Member State or in a third country.
– the CIU’s prospectus or an equivalent document includes:
• the categories of assets in which the CIUs is authorized to invest;
• if investment limits apply, the relative limits and the methodologies to
calculate them;
– the business of the CIU is reported on at least an annual basis to enable an
assessment to be made of the assets and liabilities, income and operations
over the reporting period.
• Banks may rely on third parties to calculate the capital requirement for
the credit risk relating to shares in CIUs. Specifically, this task may be
performed by the asset management company that operates the CIU
or the depository bank or financial institutions. Banks shall evaluate
this choice carefully, taking into account the size and complexity of the
CIU for which they are granting the engagement.
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12. Exposures Secured by Mortgages on Immovable Property
• An exposure or any part of an exposure fully secured by mortgage on
immovable property shall be assigned a risk weight of 100% where next rules
are not met, except for any part of the exposure which is assigned to another
exposure class. The part of the exposure that exceeds the mortgage value of
the property shall be assigned the risk weight applicable to the unsecured
exposures of the counterparty involved.
• The part of an exposure treated as fully secured by immovable property shall
not be higher than the pledge amount of the market value or in those Member
States that have laid down rigorous criteria for the assessment of the mortgage
lending value in statutory or regulatory provisions, the mortgage lending value
of the property in question.
• Based on data collected and any other relevant indicators, the competent
authorities shall periodically, and at least annually, assess whether the risk
weight of 35% for exposures secured by mortgages on residential property and
the risk weight of 50% for exposures secured on commercial immovable
property located in their territory are appropriately based on:
a) the loss experience of exposures secured by immovable property;
b) forward-looking immovable property markets developments.
• Competent authorities may set a higher risk weight from 35%/50% to 150%.
Institutions shall have a 6-month transitional period to apply the new risk
weight.
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Exposures Secured by Mortgages on
Immovable Property
• The property value shall be adequately and frequently monitored.
i. the value of the property shall be verified at least once every 3
years for residential property and once every year for commercial
real estate, or more frequently where the market is subject to
significant changes in conditions. Statistical methods may also be
used to monitor the value of the property and to identify property
that requires verification;
ii. If the valuation reveals a material decline in the value of the
property, a valuation shall be made by an independent valuer,
based on a value that shall not exceed the market value; the
property valuation shall be reviewed by an independent valuer at
least once every 3 years for exposures exceeding €3 million or 5%
of the bank’s supervisory capital;
• the types of property accepted as collateral and the related lending
policies shall be clearly documented;
• the property serving as collateral shall be adequately insured against
damage.
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11. Exposures fully and completely secured by
mortgages on residential property
• Unless otherwise decided by the competent authorities, exposures fully
and completely secured by mortgages on residential property shall be
treated as follow:
- exposures or any part of an exposure fully and completely secured by
mortgages on residential property which is or shall be occupied or let
by the owner, or the beneficial owner in the case of personal
investment companies, shall be assigned a risk weight of 35%;
- exposures to a tenant under a property leasing transaction
concerning residential property under which the institution is the lessor
and the tenant has an option to purchase, shall be assigned a risk
weight of 35% provided that the exposure of the institution is fully and
completely secured by its ownnership of the property.
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Exposures secured by mortgages on residential property
• Institutions shall consider an exposure or any part of an exposure as fully and
completely secured only if the following conditions are met:
- the value of the property shall not materially depend upon the credit quality
of the borrower. Institutions may exclude situations where purely macro-
economic factors affect both the value of the property and the performance of
the borrower from their determination of the materiality of such dependence;
- the risk of the borrower shall not materially depend upon the performance of
the underlying property or project, but on the underlying capacity of the
borrower to repay the debt from other sources, and as a consequence, the
repayment of the facility shall not materially depend on any cash flow
generated by the underlying property serving as collateral. For those other
sources, institutions shall determine maximum loan-to-income ratios as a part
of their lending policy and obtain suitable evidence of the relevant income
when granting the loan;
- the part of the loan to which the 35% risk weight is assigned does not
exceed 80% of the market value of the property in question or 80% of the
mortgage lending value of the property in question in those Member States
that have laid down rigorous criteria for the assessment of the mortgage
lending value in statutory or regulatory provisions.
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Exposures secured by mortgages on residential property
• Institutions may derogate from points 1 and 2 of the preceding slide for
exposure fully and completely secured by mortgages on residential property
which is situated within the territory of a Member State where the competent
autorithy has published evidence showing that a well-developed and long-
established residential property market is present in that territory with loss
rates which do not exceed the following limits:
- losses stemming from lending collateralised by residential property up to 80%
of the market value or 80% of the mortgage lending value do not exceed 0,3%
of the outstanding loans collateralised by residential property in any given
year;
- overall losses stemming from lending collateralised by residential property do
not exceed 0,5% of the outstanding loans collateralised by residential property
in any given year
- if either of the limits is not satisfied in a given year, the bank cannot use
these rules and the condition contained in points 1 and 2 of the preceding slide
shall apply until the conditions are satisfied in a subsequent year.
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Exposures secured by mortgages on commercial
immovable property
• Unless otherwise decided by the competent authorities, exposures fully
and completely secured by mortgages on commercial immovable
property shall be treated as follows:
- exposures or any part of an exposure fully and completely secured by
mortgages on offices or other commercial premises may be assigned a
risk weight of 50%;
- exposures related to property leasing transactions concerning offices
or other commercial premises under which the institution is the lessor
and the tenant has an option to purchase may be assigned a risk
weight of 50% provided that the exposure of the institution is fully and
completely secured by its ownership of the property

immovable property
• Institutions shall consider an exposure or any part of an exposure as fully and
completely secured only if the following conditions are met:
- the value of the property shall not materially depend upon the credit quality
of the borrower. Institutions may exclude situations where purely macro-
economic factors affect both the value of the property and the performance of
the borrower from their determination of the materiality of such dependence;
- the risk of the borrower shall not materially depend upon the performance of
the underlying property or project, but on the underlying capacity of the
borrower to repay the debt from other sources, and as a consequence, the
repayment of the facility shall not materially depend on any cash flow
generated by the underlying property serving as collateral;
- the 50% risk weight shall be assigned to the part of the loan that does not
exceed 50% of the market value of the property or 60% of the mortgage
lending value of the property in question in those Member States that have
laid down rigorous criteria for the assessment of the mortgage lending value in
statutory or regulatory provisions.
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immovable property
• Institutions may derogate from points 1 and 2 of the preceding slide for
exposure fully and completely secured by mortgages on commercial property
which is situated within the territory of a Member State where the competent
autorithy has published evidence showing that a well-developed and long-
established residential property market is present in that territory with loss
rates which do not exceed the following limits:
- losses stemming from lending collateralised by commercial property up to
50% of the market value or 60% of the mortgage lending value do not exceed
0,3% of the outstanding loans collateralised by commercial immovable
property;
- overall losses stemming from lending collateralised by commercial immovable
property do not exceed 0,5% of the outstanding loans collateralised by
commercial immovable property;
- if either of the limits is not satisfied in a given year, the bank cannot use
these rules and the condition contained in points 1 and 2 of the preceding slide
shall apply until the conditions are satisfied in a subsequent year.
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13. Exposures in the form of covered bonds
• Covered bonds for which a credit assessment by a nominated ECAI
is not available shall be assigned a risk weight on the basis of the
risk weight assigned to senior unsecured exposures to the institutio
which issues them. The following correspondence between risks
weights shall apply:
Risk weight of exposures to
the issuing bank
Risk weight of the exposures in
the form of covered bonds
20% 10%
50% 20%
100% 50%
150% 100%

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• Covered bonds for which a credit assessment by a nominated ECAI is
available shall be assigned a risk weight according to the table:
1 10%
2 - 3 20%
4 - 5 50%
6 100%

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• Exposures in the form of covered bonds are eligible for preferential
treatment, provided that the institution investing in the covered bonds
can demonstrate to the competent authorities that:
a) it receives portfolio information at least on:
- the value of the cover pool and outstanding covered bonds;
- the geographical distribution and type of cover assets, loan size,
interest rate and currency risks;
- the maturity structure of cover assets and covered bonds;
- the percentage of loans more than ninety days past due;
b) the issuer makes the information referred to in point a) available to
the institution at least semi annually.

Exposures in default
• Default of an obligor:
A default shall be considered to have occurred with regard to a particular
obligor when either or both of the following have taken place:
a) the institution considers that the obligor is unlike to pay its credit obligations
to the bank without recourse by the institution to actions such as realising
security;
b) the obligor is past due more than 90 days on any material obligation to the
bank.
In the case of retail exposures, institutions may apply the definition of default
laid down in points a) and b) at the level of an individual credit facility rather
thanin relation to the total obligations of a borrower.
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Exposures in default
• The unsecured part of any item where the obligor has defaulted or in the case
of retail exposures , the unsecured part of any credit facility which has
defaulted shall be assigned a risk weight of:
– 150%, if specific credit risk adjustments are less than 20% of the
unsecured part of the exposure value if these specific credit risk
adjustments were not applied;
– 100% if specific credit risk adjustments are no less than 20% of the
unsecured part of the exposure value if these specific credit risk
adjustments were not applied.
• Default exposures include:
– bad debts/substandard loans (non-accrued status), restructured exposures;
– exposures past due by more than 90 days.
• For the purpose of determining the secured part of the past due item, eligible
collateral and guarantees shall be those eligible for credit risk mitigation.
• The exposure value remaining after specific credit risk adjustments of
exposures fully and completely secured by mortgages on residential property
or on commercial immovable property shall be assigned a risk weight of 100%.
BF&RM - A.Y. 2022/2023

BF&RM - A.Y. 2022/2023 42
Items associated with particular high-risk
• Institutions shall assign a 150% risk weight to exposures, including exposures
in the form of shares or units in a CIU that are associated with particularly high
risks, where appropriate.
• Exposures with particularly high risks shall include any of the following
exposures:
- investment in venture capital firms;
- investment in AIFs (alternative investment fund) except where the mandate
of the fund does not allow a leverage higher than that required under Article
51 of Directive 2009/65;
- investments in private equity;
- speculative immovable property financing.
When assessing whether an exposure other than exposures referred before is
associated with particularly high risks, the bank shall take into account the
following risk characteristics:
a) there is a high risk of loss as a result of a default of the obligor;
b) it is impossible to assess adequately whether the exposure falls under point
a).

Equity exposures
• The following exposures shall be considered equity exposures:
a) non-debt exposures conveying a subortinated, residual claim on the
assets or income of the issuer;
b) debt exposures and other securities, partnerships, derivatives, or
other vehicles, the economic substance of which is similar to the
exposures specified in point a).
Equity exposures shall be assigned a risk weight of 100% unless they are
required to be deducted from the supervisory capital, assigned a 250%
risk weight for particular items not deducted, assigned 1250% risk
weight to qualifying holdings or treated as high risk items.
Investments in equity or regulatory capital instruments issued by banks
shall be classified as equity claims, unless deducted from own funds or
attracting a 250% risk weight or treated as high risk items.
BF&RM - A.Y. 2022/2023 43

Other items
• Tangible assets shall be assigned a risk weight of 100%.
• Prepayment and accrued income for which a bank is unable to
determine the counterparty shall be assigned a risk weight of
100%.
• Cash items in the process of collection shall be assigned a 20%
risk weight. Cash in hand and equivalent cash items shall be
assigned a 0% risk weight.
• Gold bullion held in own vaults or on an allocated basis to the
extent backed by bullion liabilities shall be assigned a 0% risk
weight.
• In the case of asset sale and repurchase agreements and
outright forward purchases, the risk weight shall be that
assigned to the assets in question and not to the counterparties
to the transactions.
BF&RM - A.Y. 2022/2023 44

45
Off-balance sheet transactions
• Guarantees and commitments: to calculate the credit risk associated with
guarantees and commitments issued, the bank shall first calculate the credit
equivalent amount of the exposure. Next it shall calculate the capital
requirement by multiplying the credit equivalent amount by the specific risk
weight of the counterparty.
• The credit equivalent amount shall be calculated by applying credit
conversion factors that take account of the higher or lower probability that
the guarantee or commitment could be transformed into an on-balance-sheet
exposure. One of the following credit conversion factors shall be applied to the
exposures:
– low risk = 0%;
– medium-low risk = 20%;
– medium risk = 50%;
– full risk = 100%.
• In the case of asset sale and repurchase agreements and outright forward
purchases, the risk weights shall be those of the assets in question and not
those of the counterparties to the transactions.
• Where a bank provides credit protection for a basket of exposures under terms
that the nth default among the exposures shall trigger payment and that this
credit event shall terminate the contract, and where the product has an
external credit assessment from an eligible ECAI, the risk weights prescribed
by the regulations governing securitization shall apply.
BF&RM - A.Y. 2022/2023

BF&RM - A.Y. 2022/2023 46
Off-balance sheet transactions
• If the product is not rated by an ECAI or if the bank does not use
assessments from ECAIs, the risk weights of the exposures included in
the basket shall be aggregated, excluding n-1 exposures, up to
maximum of 1,250% and multiplied by the nominal amount of the
protection provided by the credit derivative to obtain the risk weighted
exposure amount.
• The n-1 exposures to be excluded from the basket shall be determined
on the basis that they shall include those exposures each of which
produces a lower risk-weighted exposure amount than the risk-
weighted exposure amount of any of the exposures included in the
aggregation.
• Derivatives and long settlement transactions
• The exposure value of derivative contracts and long settlement
transactions shall be calculated in accordance with the procedures set
out for counterparty risk.

BF&RM - A.Y. 2022/2023 47
Credit Risk Mitigation Techniques (CRM)
• Definition: contracts accessory to the loan or of other instruments
and techniques that give rise to a reduction in credit risk that is
recognized in determining capital requirements.
• The scope for using CRM techniques has been expanded with respect
to the previous prudential regulations. This extension has been
accompanied by more specific legal, financial and organizational
eligibility requirements for supervisory recognition and more precise
methods for calculating the resulting reduction in risk (and hence, the
capital requirement).
• All banks may adopt CRM techniques regardless of the method
selected for calculating credit risk capital requirements: standardized,
foundation IRB or advanced IRB.
• The CRM techniques recognized for all capital requirement calculation
methods shall be divided into 2 general categories:
1. funded credit protection and
2. unfunded credit protection.

48
1. Funded credit protection shall consist of:
• financial collateral – in the form of cash, certain financial instruments and
gold – given through pledge agreements, the transfer of title as a
guarantee, repurchase transactions, and securities lending and borrowing
transactions;
• master netting agreements covering repurchase transactions, securities
lending and borrowing transactions and margin lending transactions;
• on-balance-sheet netting;
• real estate mortgages and lease transactions involving real estate with
the characteristics specified in these regulations;
• other collateral usable only by banks adopting IRB approaches (“eligible
IRB collateral”). These include the assignment of receivables and other
physical collateral – relating to assets other than those used as financial
collateral and encumbered by mortgages – given through, for example,
pledges or leases.
2. Unfunded credit protection shall consist of:
• guarantees;
• credit derivatives.
• Both general and specific eligibility requirements shall apply to the various
CRM techniques. Such requirements shall be met at the time the guarantee is
established and compliance shall continue over its duration.
BF&RM - A.Y. 2022/2023

49
• The general requirements, which seek to ensure the legal certainty and
effectiveness of guarantees, concern:
– the binding nature of the legal commitment between the parties;
– the enforceability;
– the documentability;
– the enforceability of the instrument in all relevant jurisdictions against third
parties with regard to establishment;
– the liquidation and the timeliness of liquidation in the event of breach.
• Specific requirements are prescribed for the features of each form of CRM and
are designed to ensure a high degree of effectiveness of the credit protection.
• The calculation methods vary depending on the instrument used and the
method followed by the bank in calculating the capital requirements.
• In the case of unfunded credit protection (guarantees or credit derivatives), a
lending bank that adopts the standardized approach or the foundation IRB
approach may apply the principle of substitution (= the substitution of the
borrower’s risk weight or probability of default (PD) with the protection
provider’s risk weight or PD). Protection providers shall have a high credit
standing and are therefore specifically identified.
BF&RM - A.Y. 2022/2023

50
CRM: funded credit protection
• Financial collateral
• Credit risk mitigation techniques include collateral and other equivalent rights
having as object assets featuring an adequate degree of liquidity and a
sufficiently stable market value over time, such as gold, cash deposits or other
financial instruments specifically identified. For example, these include collateral
given through pledges, contracts for the transfer of property serving as
collateral, credit linked notes, and repurchase/reverse repurchase and securities
lending/securities borrowing transactions, provided that they are assigned to
the banking book.
• Specific requirements. For supervisory capital purposes, financial collateral
shall have the following characteristics:
– Correlation – There shall be no positive material correlation between the
value of the financial collateral and the credit quality of the borrower.
In all cases, securities issued by the borrower, or any related group entity,
shall not be eligible to be financial collateral.
Covered bonds issued by banks belonging to the same group as the
borrower may be accepted as financial collateral in repurchase transactions
provided that they comply with the requirements for applying the reduced
weight under the standardized approach and there is no positive material
correlation between the value of the bond and the credit quality of the
borrower.
BF&RM - A.Y. 2022/2023

BF&RM - A.Y. 2022/2023 51
– Fair value – Banks shall be able to calculate the fair value of the
collateral and revalue it with a minimum frequency of once every 6
months or whenever they have reason to believe that a significant
decrease in its fair value has occurred.
– Segregation – Where the financial collateral is held by a third
party, banks shall ensure segregation of the assets of the third
party from the collateral (external segregation) and the segregation
of assets belonging to other parties held by the same custodian
(internal segregation).
In general, the segregation requirement may be deemed satisfied
where the pledged instruments are specifically identified and
attributable to the owner (for example, in the case of registered
securities) or where, although fungible, the assets are held under a
contractually governed custodial arrangement or using methods
that ensure internal and external segregation.

BF&RM - A.Y. 2022/2023 52
• Calculation methods. In calculating the capital requirement for credit
exposures secured by eligible financial collateral, banks may use the simple
method or the comprehensive method.
• Under the simple method, the risk weight associated with the instrument
provided as credit protection shall be applied to the collateralized portion of the
exposure.
• Under the comprehensive method the amount of the exposure shall be
reduced by the value of the collateral in calculating the requirement. The value
of the exposure and that of the collateral shall be adjusted to take account of
market price volatility by applying appropriate haircuts to both amounts
(collateral value and exposure value). Unless cash is involved, the exposure
value adjusted for volatility shall be higher than that of the original exposure,
while the adjusted value of the collateral shall be lower than its original value.
• If the exposure and the collateral are denominated in different currencies, the
value of the collateral shall be further reduced by an appropriate adjustment
that reflects possible fluctuations in the exchange rate.
• Once the calculation method is elected, it shall be adopted for all exposures.
• Maturity mismatching is not permitted under the simple method.

BF&RM - A.Y. 2022/2023 53
Simple Method
• The risk weight envisaged for instruments provided as collateral shall
apply, entirely or proportionately, to exposures secured, respectively,
in whole or in part by financial collateral.
• The unsecured portion of the exposure shall receive the counterparty’s
(borrower’s) risk weight.
• The risk weight applied to the collateralized portion of the exposure
shall be at least 20%, except in the cases expressly provided for.
• The collateral shall be assigned a value equal to the fair value of the
underlying instrument.
• Risk weights: exceptions to the 20% minimum threshold
• The secured portion of the following transactions may receive a risk
weight of 0% provided that the following conditions are met:
1. Repurchase transactions and securities lending and borrowing
transactions, where:
a. both the exposure and the collateral are cash or debt
securities issued by specified persons and receive a risk weight
of 0% for the purposes of calculating the capital requirement;

BF&RM - A.Y. 2022/2023 54
Simple Method
b. both the exposure and the collateral are denominated in the same
currency;
c. either the maturity of the transactions does not exceed one day or
both the exposure and the collateral are subject to daily marking-to-
market or daily remargining;
d. the time between the last marking-to-market before a failure to
remargin by the counterparty and the liquidation of the collateral does
not exceed 4 business days;
e. the settlement of the transactions occurs within a settlement system
proven for that type of transaction;
f. the documentation covering the agreement is standard market
documentation for these types of transactions;
g. the documentation governing the transaction provides for immediate
termination in the event the counterparty fails to physically deliver
cash, securities or margins or otherwise defaults;
h. the counterparty is a core market participant.

55
Simple Method
2. Over-the-counter derivatives transactions listed in the regulations governing
counterparty risk whose exposure is calculated in accordance with such
regulations, subject to daily marking-to-market, collateralized by cash or cash-
assimilated instruments where there is no currency mismatch.
3. Transactions in which the exposure and the collateral are denominated in the
same currency and the collateral is either:
• cash on deposit or a cash assimilated instrument;
• debt securities issued by one of the entities specified, excluding public
sector entities, if such securities have a 0% risk weight for the purpose of
calculating the capital requirement and their fair value has been discounted
by 20%.
• Where a supervisory authority of a Member State has authorized the
application of a 0% risk weight for repurchase transactions and securities
lending and borrowing transactions involving securities issued by that
sovereign, Italian banks may apply the same preferential treatment.
• Banks shall apply a 10% risk weight to the secured portion of exposures
connected with the transactions specified in point 1 where the counterparty is
not a core market participant. The OTC derivatives transactions (2.) shall also
be subject to the same risk weight if they are secured by debt securities issued
by one of the entities specified, excluding public sector entities, if such
securities have a 0% risk weight for the purpose of calculating the capital
requirement.
BF&RM - A.Y. 2022/2023

BF&RM - A.Y. 2022/2023 56
Comprehensive Method
• It allows banks to take more direct account of the credit risk mitigation
effect of financial collateral.
• The risk weight for an assets secured by eligible financial collateral
shall be obtained by multiplying the risk weight of the counterparty by
an amount equal to the difference between the exposure amount and
the value of the collateral.
• In order to take account of market price volatility, an appropriate
haircut shall be applied to both the collateral value and the exposure
amount. With the exclusion of cash, the volatility-adjusted exposure
value shall be higher than the value of the original exposure, and vice-
versa for collateral.
• Where the exposure and the collateral are denominated in difference
currencies, the amount of the collateral shall be further reduced to
reflect possible foreign exchange volatility.

BF&RM - A.Y. 2022/2023 57
• The exposure value under the comprehensive method shall be
calculated as follows:
where
E* = “adjusted” exposure, which takes into account the credit risk
mitigation effects of the financial collateral as well as volatility;
E = exposure value used to calculate the capital requirement. In the
case of off-balance-sheet positions, the exposure shall be the nominal
value, i.e. applying a credit conversion factor of 100%;
C = market value of the collateral;
HE = haircut appropriate to the exposure;
HC = haircut appropriate to the collateral;
HFX = foreign exchange haircut.
( ) ( )
 
* max 0; 1 1
E C FX
E E H C H H
=  + − − −
 
 

BF&RM - A.Y. 2022/2023 58
• In the case of exposures represented by loans and derivatives  HE =
0. Banks may apply a haircut of zero to repurchase transactions and
securities lending and borrowing transactions only where they possess
the characteristics set out.
• Where a supervisory authority of a Member State has authorized the
application of a zero haircut for repurchase transactions and securities
lending and borrowing transactions involving securities issued by that
sovereign, Italian banks may apply the same preferential treatment.
• Where the collateral consists of a number of eligible instruments, the
haircut shall be:
where
ai = proportion of the individual instrument to the total value of the
collateral
Hi = applicable haircut.
i i
i
H a H
= 

59
• Where the bank revalues the exposure and the collateral on a less-than-daily
basis, the haircuts applicable in the case of daily revaluation shall be scaled up
using the following formula:
where
H = haircut to be applied;
HM = haircut under daily revaluation;
NR = actual number of business days between revaluations (NR > 1);
TM = liquidation period for the transaction.
• In order to calculate haircuts, banks may use the parameters specified in
“supervisory haircuts” section, or their own estimates under “estimated
haircuts” section.
• If the second approach is chosen, it shall be used for the full range of existing
secured exposures, excluding immaterial portfolios, for which the supervisory
haircut approach may be used.
( )
 
1
M R M M
H H N T T
= + −
 
 
BF&RM - A.Y. 2022/2023

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