Is There Any Credit in Basel IV?

1. Is There Any Credit in Basel IV?
The Evolving Supervisory Architecture
Credit Risk Implications
Tuesday 8 November 2016
Robert Talbot

2. 2014
Dec 2014 – Mar 2015: Capital floors: the design of a framework based on standardised approaches
http://www.bis.org/bcbs/publ/d306.pdf
Dec 2014 – Mar 2015: Revisions to the Standardised Approach for credit risk
http://www.bis.org/bcbs/publ/d307.pdf
2015
Nov 2015: Finalising post-crisis reforms: an update – A report to G20 Leaders
http://www.bis.org/bcbs/publ/d344.pdf
Dec 2015 – Mar 2016: Revisions to the Standardised Approach for credit risk (second consultative document)
http://www.bis.org/bcbs/publ/d347.pdf
2016
March 2016 – June 2016: Reducing variation in credit risk-weighted assets – constraints on the use of
internal model approaches
http://www.bis.org/bcbs/publ/d362.pdf
2013 July 2013 – Oct 2013: The regulatory framework: balancing risk sensitivity, simplicity and comparability
http://www.bis.org/publ/bcbs258.pdf
Credit Risk: Recent Evolution
Supervisors have expressed concerns regarding the use of internal model approaches for
Credit Risk …

3. Why?
Supervisors noted that RWAs across different jurisdictions were very different:
questions were raised about the regulatory framework

4. Simplicity
• Limited number of approaches
• Observable inputs
• Limited assumptions
• Details easy to understand &
communicate
• Data availability
Comparability
• Similar outputs for similar risks
• Different outputs for different
risks
• Implementable across
jurisdictions
• Enhanced disclosure
Risk Sensitivity
• Account taken of different
types and sources of risk
• Differentiated response to level
of risk
• Risk of regulatory arbitrage is
low
What do Supervisors Want?
Supervisors desire to strike a balance between Simplicity, Comparability and Risk
Sensitivity:

5. 01
Removal of IRB Approaches for Certain Exposures:
• Banks / Financial Institutions
• Large Corporates
• Corporates part of a Consolidated Group with revenues exceeding €200m
• Specialised Lending
• Equities
02
Impose Floors on Model Outputs
• Exposure-level Parameter Floors
• Aggregate RWA Floor based upon Revised Standardised Approach
03
Enhanced Specification of Parameter Estimation Practices
• PD, LGD, EaD/CCF, M and CRM
The proposed changes to the IRB Approach are seen as a key element of the regulatory
reform programme. These changes are significant:
Is IRB to Undergo Open-Heart Surgery?
And will the patient recover or will we have a Frankenstein’s Monster?

6. Potential Impact on European Banks is Severe
It is estimated that the impact from the IRB proposals alone will increase European
banks’ RWAs by 15% – 30%, increasing to 55% when other Basel IV proposals included:
Source: European Banking Federation

7. Retain a central role for IRB in the capital framework
• Improved risk management
• Risk-sensitivity: pricing/portfolio management/incentives/capital allocation
Consider changes holistically
• Interaction of IRB proposals and SA
• Cumulative impact of Credit Risk along with Op Risk, FRTB, Leverage Ratio
• Downstream impacts, eg. Securitisation
Industry Engagement
Four main banking federations met with the Basel Committee on 23 June …

8. Better ways to address RWA Variance
• Acknowledge that RWA variance needs to be reduced; although a substantial
portion is due to regulator discrepancies
• Harmonisation agenda: IRTF recommendations; EBA review should be given
opportunity to run its course
• Harmonise and improve models, don’t abandon them
Industry Engagement
Four main banking federations met with the Basel Committee on 23 June …
Potential for a significant increase in overall capital requirements
• Capital increases already achieved post-crisis; diminishing returns
• Criticality of QIS, and the very limited timeframe for thorough analysis
• Sharp adverse impacts for banks’ ability to lend to strong credits, unrated counterparties, trade finance,
infrastructure, ship and aircraft finance, property
• Final adjustments to overall calibration will not compensate for loss of risk sensitivity

9. Reduce Variation or Enhance Understanding
• Recommendations of BCBS Regulatory Consistency Assessment Program (RCAP), April 2016
• European Banking Authority (EBA) initiative: Supervisory Benchmarking, Single Rulebook, recalibration / re-approval
of models by 2020, ECB Targeted Review of Internal Models (TRIM)
Harmonisation Agenda
In particular, the Industry noted that greater efforts could be made to harmonise
Internal Models …
Key Drivers of Variation
• Supervisory Review
• Definition of Default
• Nature, duration and severity of an Economic Downturn
• PD: Model Philosophy – PiT, Hybrid, TtC
• LGD Discount Factor, Credit Risk Mitigation
• LGD in Default, Unresolved Cases, Backtesting
• LGD / EaD: Definition of LRA / Downturn

10. Supervisory Approach Counterproductive
The Industry also argued that the proposals appeared inconsistent with the stated
objectives …
Simplicity
• Too many floors with complex, non-transparent interaction
Comparability
• Floors have no economic meaning
• Standardised approach ignores economic, legal and institution-specific differences
• Higher-risk portfolios may appear to have similar RWA as lower-risk portfolios
• Holistic assessment of banks may mislead: illusion of comparability
Risk Sensitivity
• Lower risk assets penalised
• Discourages granularity of risk measurement
• High-risk assets favored over low-risk assets to ensure shareholder return

11. IRB Approach still Available for Large Corporates
• Foundation-IRB Approach
• Revenue threshold on Consolidated Groups to be raised, possibly to €500m
IRB Approach still Available for Banks & Financial Institutions
• Foundation-IRB Approach very possible
• Banks and other Financial Institutions to be split up?
IRB Approach still Available for Specialised Lending – or is it?
• Less certain outcome, potential changes within IRB context, Standardised?
• IPRE definition may be refined: possible impact on BTLs?
Aggregate Standardised Floor in Range 70% – 80%
• U.S. pushing for higher range, E.U. for lower
Probable Outcomes
Based upon Industry sources, in turn based upon informal discussions …

12. Robert Talbot
Head of Capital Models
Allied Irish Banks - Head Office
Bankcentre, Ballsbridge, Dublin 4, Ireland
Email: robert.p.talbot@aib.ie
Phone: +353 1 641 4598