Basel
ii in the United States of America
From the
Basel ii
Compliance Professionals Association (BCPA),
the largest association of Basel ii Professionals in the
world
Final Rule, USA: Risk-Based Capital Standards:
Advanced Capital Adequacy Framework — Basel II
Quantification of risk parameters for wholesale and
retail exposures
A bank
must have a comprehensive risk parameter quantification
process that produces accurate, timely, and reliable
estimates of the risk parameters – PD, LGD, EAD, and
(for wholesale exposures) M – for its wholesale obligors
and exposures and retail exposures.
Statistical methods and models used to develop risk
parameter estimates, as well as any adjustments to the
estimates or empirical data, should be transparent, well
supported, and documented.
The
following sections of the preamble discuss the rule’s
definitions of the risk parameters for wholesale
exposures and retail segments.
Probability of default (PD)
As
noted above, under the final rule, a bank must assign
each of its wholesale obligors to an internal rating
grade and then must associate a PD with each rating
grade.
PD for
a wholesale exposure to a non-defaulted obligor is the
bank’s empirically based best estimate of the long-run
average one-year default rate for the rating grade
assigned by the bank to the obligor, capturing the
average default experience for obligors in the rating
grade over a mix of economic conditions (including
economic downturn conditions) sufficient to provide a
reasonable estimate of the average one-year default
rate
over the economic cycle for the rating grade.
In
addition, under the final rule, a bank must assign a PD
to each segment of retail exposures.
Some
types of retail exposures typically display a seasoning
pattern – that is, the exposures have relatively low
default rates in their first year, rising default rates
in the next few years, and declining default rates for
the remainder of their terms.
Because of the one-year IRB horizon, the proposed rule
provided two different definitions of PD for
a
segment of non-defaulted retail exposures based on the
materiality of seasoning effects for the segment or for
the segment’s retail exposure subcategory.
Under
the proposed rule, PD for a segment of non-defaulted
retail exposures for which seasoning effects were not
material, or for a segment of non-defaulted retail
exposures in a retail exposure subcategory for which
seasoning effects were not material, would be the bank’s
empirically based best estimate of the long-run average
of one-year default rates for the exposures in the
segment, capturing the average default experience for
exposures in the segment over a mix of economic
conditions (including economic downturn conditions)
sufficient to provide a reasonable estimate of the
average one-year default rate over the
economic cycle for the segment.
PD for
a segment of non-defaulted retail exposures for which
seasoning effects were material would be the bank’s
empirically based best estimate of the annualized
cumulative default rate over the expected remaining life
of exposures in the segment, capturing the average
default experience for exposures in the segment over a
mix of economic conditions (including economic downturn
conditions) to provide a reasonable estimate of the
average performance over the economic cycle for the
segment.
Commenters objected to this treatment of retail
exposures with material seasoning effects.
They
asserted that requiring banks to use an annualized
cumulative default rate to recognize seasoning effects
was too prescriptive and would preclude other reasonable
approaches.
The
agencies believe that commenters have presented
reasonable alternative approaches to recognizing the
effects of seasoning in PD and are, therefore, providing
additional flexibility for recognizing those effects in
the final rule.
Based
on comments and additional consideration, the agencies
also are clarifying that a segment of retail exposures
has material seasoning effects if there is a material
relationship between the time since origination of
exposures within the segment and the bank’s best
estimate of the long-run average one-year default rate
for the exposures in the segment.
Moreover, because the agencies believe that
the IRB
approach must, at a minimum, require banks to hold
appropriate amounts of risk-based capital to address
credit risks over a one-year horizon, the final rule’s
incorporation of seasoning effects is explicitly
one-directional.
Specifically, a bank must increase PDs above the best
estimate of the long-run average one-year default rate
for segments of unseasoned retail exposures, but may not
decrease PD below the best estimate of the long-run
average one year default rate for a segment of retail
exposures that the bank estimates will have lower
PDs
in future years due to seasoning.
The
final rule defines PD for a segment of non-defaulted
retail exposures as the bank’s empirically based best
estimate of the long-run average one-year default rate
for the exposures in the segment, capturing the average
default experience for exposures in the segment over a
mix of economic conditions (including economic downturn
conditions) sufficient to provide a reasonable estimate
of the average one-year default rate over the economic
cycle for the segment and adjusted upward as appropriate
for segments for which seasoning effects are material.
If a
bank does not adjust PD to reflect seasoning effects for
a segment of exposures, it should be able to demonstrate
to its primary Federal supervisor, using empirical
analysis, why seasoning effects are not
material or why adjustment is not relevant for the
segment.
For
wholesale exposures to defaulted obligors and for
segments of defaulted retail exposures,
PD is 100
percent.
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