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
Supervisory mapping function
The
proposed rule provided banks two methods of generating
LGD estimates for wholesale exposures and retail
segments.
First,
a bank could use its own estimates of
LGD for a
subcategory of exposures if the bank had prior written
approval from its
primary Federal supervisor to use internal estimates for
that subcategory of exposures.
In
approving a bank’s use of internal estimates of LGD, a
bank’s primary Federal supervisor would consider whether
the bank’s internal estimates of LGD were reliable and
sufficiently reflective of economic downturn conditions.
The
supervisor would also consider whether the bank has
rigorous and well-documented policies and procedures for
identifying economic downturn conditions for the
exposure subcategory, identifying
material adverse correlations between the relevant
drivers of default rates and loss rates given default,
and incorporating identified correlations into internal
LGD estimates.
If a
bank had supervisory approval to use its own estimates
of LGD for an exposure subcategory, it would use its own
estimates of LGD for all exposures within that
subcategory.
As an
alternative to internal estimates of LGD, the proposed
rule provided a supervisory mapping function for
converting ELGD into LGD for risk-based capital
purposes.
A bank
that did not qualify to use its own estimates of LGD for
a subcategory of exposures would instead compute LGD
using the linear supervisory mapping function:
LGD
= 0.08 + 0.92 x ELGD.
A bank
would not have to apply the supervisory mapping function
to repo-style transactions, eligible margin loans, and
OTC derivative contracts (defined below in section V.C.
of this preamble).
The
agencies proposed the supervisory mapping function
because of concerns that banks may find it difficult to
produce internal estimates of LGD that are sufficient
for risk-based capital purposes because LGD data for
important portfolios may be sparse, and there is limited
industry experience with incorporating downturn
conditions into LGD estimates.
The
supervisory mapping function provided a pragmatic
methodology for banks to use while refining their LGD
estimation techniques.
In
general, commenters viewed the supervisory mapping
function as a significant deviation from the New Accord
that would add unwarranted prescriptiveness and
regulatory burden to the U.S. rule. Commenters requested
more flexibility to address problems with LGD
estimation, including the ability to apply appropriate
margins of conservatism as contemplated in the New
Accord.
Commenters expressed concern that U.S. supervisors would
employ an unreasonably high standard for allowing own
estimates of LGD, forcing banks to use the supervisory
mapping function for an extended
period
of time.
Commenters also expressed concern that supervisors would
view the output of the supervisory mapping function as a
floor on internal estimates of LGD.
Commenters asserted that in both cases risk-based
capital requirements would be increased at U.S. banks
relative to their foreign competitors, particularly for
high-quality assets, putting U.S. banks at a competitive
disadvantage to foreign banks.
In
particular, many commenters viewed the supervisory
mapping function as overly punitive for exposure
categories with relatively low loss severities,
effectively imposing an 8 percent floor on LGD.
Commenters also objected to the proposed requirement
that a bank use the supervisory mapping function for an
entire subcategory of exposures even if it had
difficulty estimating LGD only for a small subset of
those
exposures.
The
agencies continue to believe that the supervisory
mapping function is a reasonable aid for dealing with
problems in LGD estimation.
The
agencies recognize, however, that there may be several
valid methodologies for addressing such problems.
For
example, a relative scarcity of historical loss data for
a particular obligor or exposure type may be addressed
by increased reliance on alternative data sources and
data enhancing tools for quantification and alternative
techniques for validation.
In
addition, a bank should reflect in its estimates of risk
parameters a margin of conservatism that is
related to the likely range of uncertainty.
These
concepts are discussed below in the quantification
principles section of the preamble.
Therefore, the agencies are not including the
supervisory mapping function in the final rule.
However, the agencies continue to believe that the
function (and associated estimation of the long-run
default-weighted average economic loss rate given
default within a one-year horizon) is one way a bank
could address difficulties in estimating
LGD.
However it chooses to estimate LGD, a bank’s estimates
of LGD must be reliable and sufficiently reflective of
economic downturn conditions, and the bank should have
rigorous and well-documented policies and procedures for
identifying economic downturn conditions for each
exposure subcategory, identifying changes in material
adverse relationships between the relevant drivers of
default rates and loss rates given
default, and incorporating identified relationships into
LGD estimates.
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