Basel III standardised credit risk assessment – What you need to know

Basel III updates take a more sensitive approach to calculating risk weightings and capital charges. Paul Whitmore, global head of counterparty risk solutions at Fitch Solutions, explains how credit risk professionals can prepare

Banks have until January 2023 to get to grips with the new standardised credit risk assessment (SCRA) approach introduced under Basel III updates. This new methodology for assigning risk weightings to unrated bank exposures will undoubtedly increase the data management burden for many banks. In addition to gathering minimum capital requirements and capital buffer requirements from any jurisdictions in which a bank has unrated exposures, banks will need to comb individual counterparties’ annual reports. 

The scale of the data management effort will depend on the size and geographic spread of a bank’s unrated portfolio, but will likely entail significant time and resources. To help banks contemplate this challenge, Paul Whitmore, global head of counterparty risk solutions at Fitch Solutions, explores the main elements of this new approach.

What kinds of banks will be affected by the new SCRA approach? 

Paul Whitmore: All internationally active banks located in jurisdictions that adhere to Basel rules will be affected and, more specifically, those with exposures to unrated banks. Many large banks currently benefit from using model-based approaches, which can lead to lower risk weightings and capital charges. With the new regulations, however, the emphasis will be on calculating risk-weighted assets (RWAs) using the non-modelled standardised approach. 

Also, banks incorporated in countries such as the US that do not allow the use of external ratings for regulatory purposes might need this data to calculate their unrated and foreign bank exposures. This will depend on the shape of the final rules in their individual jurisdictions.

What challenges do banks face with the new SCRA methodology?

Paul Whitmore: The main challenges will be around the collection and maintenance of the data from global banking jurisdictions. This was certainly the case for clients Fitch Solutions has onboarded so far. Retrieving the minimum regulatory requirements from supervisory websites can be challenging – the information is often difficult to locate and might be in a different language. 

As well as maintaining this data, banks might encounter issues in using it to process and calculate RWAs. For example, there can be differences in jurisdictions’ capital buffer requirements, with some being additive and others the higher of two amounts.

What is the aim of the output floor that will be phased in under this approach?

Paul Whitmore: It will create a more level playing field between banks that use sophisticated internal models and those using the standardised approach. It will also reduce the excessive variability of RWAs calculated under banks’ model approaches. 

Historically, larger banks typically used internal model estimates, and these could generate very low risk weightings, reducing their minimum capital requirements. Under the new regulations, these modelled capital charges will have to be at least 75% of aggregate RWAs calculated using the standardised approach. This could cause certain risk weights to increase under the SCRA approach.

How might the data required under the SCRA approach benefit banks?

Paul Whitmore: Fixed risk weightings are currently applied to unrated banks under the standardised approach, requiring more capital than typical investment-grade credit ratings. Under the new regime, provided the SCRA can be used, risk weights may fall, reducing banks’ capital requirements. 

This is because the SCRA approach is more granular than the previous unrated standardised approach. Instead of a single fixed risk weight that sees all unrated banks treated the same by regulators, SCRA has three different buckets for unrated banks. It could therefore result in a reduction in risk weights from 100% to 30% in some instances.

What should potential users look for in an SCRA data solution?

Paul Whitmore: For those that seek an external solution, finding a provider with a strong track record in collecting and maintaining high volumes of comprehensive, standardised data should be a top priority. Doing this in areas in which information is hard to find and difficult to interpret adds another layer of difficulty, and so prior experience of this would add more value.

It’s important to check the credentials of the team behind the numbers too. Sourcing this data effectively requires professionally qualified analysts and data specialists equipped with the expertise and language skills needed to analyse bank and supervisory documents from jurisdictions worldwide.

What stage should banks now be at to ensure they are fully prepared for the January 2023 implementation?

Paul Whitmore: Many banks took advantage of the extra 12 months the Basel Committee on Banking Supervision granted in March 2020 because of the Covid-19 pandemic. Most are only assessing the implications of the reforms now that draft rules are starting to be published by regulators. 

If they haven’t already, we expect banks will be performing quantitative impact studies to understand how the reforms will affect their capital calculations. They will be looking at all permutations of their internal ratings-based models, credit ratings for the external credit risk assessment approach and their current datasets to help them adhere to the SCRA guidelines. 

It is worth remembering that the larger the bank – or the broader its geographical reach – the larger the task. For banks of any size, however, preparing for this change should be a priority.

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