Introduction

Banks can choose between two broad methodologies for calculating their risk-based capital requirements for credit risk. The first is the standardised approach, which is set out in chapters CRE20 to CRE22:

The second risk-weighted capital treatment for measuring credit risk, the internal ratings-based (IRB) approach, allows banks to use their internal rating systems for credit risk, subject to the explicit approval of the bank’s supervisor. The IRB approach is set out in CRE30 to CRE36.

The treatment of the following exposures is addressed in separate chapters of the credit risk standard:

Due diligence requirements

Consistent with the Committee's guidance on the assessment of credit risk2 and paragraphs SRP20.12 to SRP20.14 of the supervisory review process standard, banks must perform due diligence to ensure that they have an adequate understanding, at origination and thereafter on a regular basis (at least annually), of the risk profile and characteristics of their counterparties. In cases where ratings are used, due diligence is necessary to assess the risk of the exposure for risk management purposes and whether the risk weight applied is appropriate and prudent.3 The sophistication of the due diligence should be appropriate to the size and complexity of banks' activities. Banks must take reasonable and adequate steps to assess the operating and financial performance levels and trends through internal credit analysis and/or other analytics outsourced to a third party, as appropriate for each counterparty. Banks must be able to access information about their counterparties on a regular basis to complete due diligence analyses.

For exposures to entities belonging to consolidated groups, due diligence should, to the extent possible, be performed at the solo entity level to which there is a credit exposure. In evaluating the repayment capacity of the solo entity, banks are expected to take into account the support of the group and the potential for it to be adversely impacted by problems in the group.

Banks should have in place effective internal policies, processes, systems and controls to ensure that the appropriate risk weights are assigned to counterparties. Banks must be able to demonstrate to their supervisors that their due diligence analyses are appropriate. As part of their supervisory review, supervisors should ensure that banks have appropriately performed their due diligence analyses, and should take supervisory measures where these have not been done.

Exposures to sovereigns

Exposures to sovereigns and their central banks will be risk-weighted as follows:

At national discretion, a lower risk weight may be applied to banks’ exposures to their sovereign (or central bank) of incorporation denominated in domestic currency and funded4 in that currency.5 Where this discretion is exercised, other national supervisors may also permit their banks to apply the same risk weight to domestic currency exposures to this sovereign (or central bank) funded in that currency.

For the purpose of risk-weighting exposures to sovereigns, supervisors may recognise the country risk scores assigned by Export Credit Agencies (ECAs). To qualify, an ECA must publish its risk scores and subscribe to the methodology agreed by the Organisation for Economic Cooperation and Development (OECD). Banks may choose to use the risk scores published by individual ECAs that are recognised by their supervisor, or the consensus risk scores of ECAs participating in the “Arrangement on Officially Supported Export Credits”.6 The OECD-agreed methodology establishes eight risk score categories associated with minimum export insurance premiums. These ECA risk scores will correspond to risk weight categories as detailed below.

Exposures to the Bank for International Settlements, the International Monetary Fund, the European Central Bank, the European Union, the European Stability Mechanism and the European Financial Stability Facility may receive a 0% risk weight.

Exposures to non-central government public sector entities (PSEs)

Exposures to domestic PSEs will be risk-weighted at national discretion, according to either of the following two options.

Subject to national discretion, exposures to certain domestic PSEs7 may also be treated as exposures to the sovereigns in whose jurisdictions the PSEs are established. Where this discretion is exercised, other national supervisors may allow their banks to risk-weight exposures to such PSEs in the same manner.

Exposures to multilateral development banks (MDBs)

For the purposes of calculating capital requirements, a Multilateral Development Bank (MDB) is an institution created by a group of countries that provides financing and professional advice for economic and social development projects. MDBs have large sovereign memberships and may include both developed and/or developing countries. Each MDB has its own independent legal and operational status, but with a similar mandate and a considerable number of joint owners.

A 0% risk weight will be applied to exposures to MDBs that fulfil to the Committee’s satisfaction the eligibility criteria provided below.8 The Committee will continue to evaluate eligibility on a case-by-case basis. The eligibility criteria for MDBs risk-weighted at 0% are:

For exposures to all other MDBs, banks incorporated in jurisdictions that allow the use of external ratings for regulatory purposes will assign to their MDB exposures the corresponding “base” risk weights determined by the external ratings according to Table 5. Banks incorporated in jurisdictions that do not allow external ratings for regulatory purposes will risk-weight such exposures at 50%.

Exposures to banks

For the purposes of calculating capital requirements, a bank exposure is defined as a claim (including loans and senior debt instruments, unless considered as subordinated debt for the purposes of CRE20.60) on any financial institution that is licensed to take deposits from the public and is subject to appropriate prudential standards and level of supervision.10 The treatment associated with subordinated bank debt and equities is addressed in CRE20.53 to CRE20.60.

Risk weight determination

Bank exposures will be risk-weighted based on the following hierarchy:11

External Credit Risk Assessment Approach (ECRA)

Banks incorporated in jurisdictions that allow the use of external ratings for regulatory purposes will assign to their rated bank exposures12 the corresponding “base” risk weights determined by the external ratings according to Table 6. Such ratings must not incorporate assumptions of implicit government support, unless the rating refers to a public bank owned by its government.13 Banks incorporated in jurisdictions that allow the use of external ratings for regulatory purposes must only apply SCRA for their unrated bank exposures, in accordance with CRE20.21.

Exposures to banks with an original maturity of three months or less, as well as exposures to banks that arise from the movement of goods across national borders with an original maturity of six months or less14 can be assigned a risk weight that correspond to the risk weights for short term exposures in Table 6.

Banks must perform due diligence to ensure that the external ratings appropriately and conservatively reflect the creditworthiness of the bank counterparties. If the due diligence analysis reflects higher risk characteristics than that implied by the external rating bucket of the exposure (ie AAA to AA–; A+ to A– etc), the bank must assign a risk weight at least one bucket higher than the "base" risk weight determined by the external rating. Due diligence analysis must never result in the application of a lower risk weight than that determined by the external rating.

Standardised Credit Risk Assessment Approach (SCRA)

Banks incorporated in jurisdictions that do not allow the use of external ratings for regulatory purposes will apply the SCRA to all their bank exposures. The SCRA also applies to unrated bank exposures for banks incorporated in jurisdictions that allow the use of external ratings for regulatory purposes. The SCRA requires banks to classify bank exposures into one of three risk-weight buckets (ie Grades A, B and C) and assign the corresponding risk weights in Table 7.15 For the purposes of the SCRA only, “published minimum regulatory requirements” in CRE20.22 to CRE20.30 excludes liquidity standards.

SCRA: Grade A

Grade A refers to exposures to banks, where the counterparty bank has adequate capacity to meet their financial commitments (including repayments of principal and interest) in a timely manner, for the projected life of the assets or exposures and irrespective of the economic cycles and business conditions.

A counterparty bank classified into Grade A must meet or exceed the published minimum regulatory requirements and buffers established by its national supervisor as implemented in the jurisdiction where it is incorporated, except for bank-specific minimum regulatory requirements or buffers that may be imposed through supervisory actions (eg via the Supervisory Review Process, SRP) and not made public. If such minimum regulatory requirements and buffers (other than bank-specific minimum requirements or buffers) are not publicly disclosed or otherwise made available by the counterparty bank, then the counterparty bank must be assessed as Grade B or lower.

If as part of its due diligence, a bank assesses that a counterparty bank does not meet the definition of Grade A in CRE20.22 and CRE20.23, exposures to the counterparty bank must be classified as Grade B or Grade C.

SCRA: Grade B

Grade B refers to exposures to banks, where the counterparty bank is subject to substantial credit risk, such as repayment capacities that are dependent on stable or favourable economic or business conditions.

A counterparty bank classified into Grade B must meet or exceed the published minimum regulatory requirements (excluding buffers) established by its national supervisor as implemented in the jurisdiction where it is incorporated, except for bank-specific minimum regulatory requirements that may be imposed through supervisory actions (eg via the Supervisory Review Process, SRP) and not made public. If such minimum regulatory requirements are not publicly disclosed or otherwise made available by the counterparty bank then the counterparty bank must be assessed as Grade C.

Banks will classify all exposures that do not meet the requirements outlined in CRE20.22 and CRE20.23 into Grade B, unless the exposure falls within Grade C under CRE20.28 to CRE20.30.

SCRA: Grade C

Grade C refers to higher credit risk exposures to banks, where the counterparty bank has material default risks and limited margins of safety. For these counterparties, adverse business, financial, or economic conditions are very likely to lead, or have led, to an inability to meet their financial commitments.

At a minimum, if any of the following triggers is breached, a bank must classify the exposure into Grade C:

Even if the triggers set out in CRE20.29 are not breached, a bank may assess that the counterparty bank meets the definition in CRE20.28. In that case, the exposure to such counterparty bank must be classified into Grade C.

Exposures to banks with an original maturity of three months or less, as well as exposures to banks that arise from the movement of goods across national borders with an original maturity of six months or less,16 can be assigned a risk weight that correspond to the risk weights for short term exposures in Table 7.

To reflect transfer and convertibility risk under the SCRA, a risk-weight floor based on the risk weight applicable to exposures to the sovereign of the country where the bank counterparty is incorporated will be applied to the risk weight assigned to bank exposures. The sovereign floor applies when: (i) the exposure is not in the local currency of the jurisdiction of incorporation of the debtor bank; and (ii) for a borrowing booked in a branch of the debtor bank in a foreign jurisdiction, when the exposure is not in the local currency of the jurisdiction in which the branch operates. The sovereign floor will not apply to short-term (ie with a maturity below one year) self-liquidating, trade-related contingent items that arise from the movement of goods.

Exposures to covered bonds

Covered bonds are bonds issued by a bank or mortgage institution that are subject by law to special public supervision designed to protect bond holders. Proceeds deriving from the issue of these bonds must be invested in conformity with the law in assets which, during the whole period of the validity of the bonds, are capable of covering claims attached to the bonds and which, in the event of the failure of the issuer, would be used on a priority basis for the reimbursement of the principal and payment of the accrued interest.

Eligible assets

In order to be eligible for the risk weights set out in CRE20.38, the underlying assets (the cover pool) of covered bonds as defined in CRE20.33 shall meet the requirements set out in CRE20.37 and shall include any of the following:

The nominal value of the pool of assets assigned to the covered bond instrument(s) by its issuer should exceed its nominal outstanding value by at least 10%. The value of the pool of assets for this purpose does not need to be that required by the legislative framework. However, if the legislative framework does not stipulate a requirement of at least 10%, the issuing bank needs to publicly disclose on a regular basis that their cover pool meets the 10% requirement in practice. In addition to the primary assets listed in this paragraph, additional collateral may include substitution assets (cash or short term liquid and secure assets held in substitution of the primary assets to top up the cover pool for management purposes) and derivatives entered into for the purposes of hedging the risks arising in the covered bond program.

The conditions set out in CRE20.34 and CRE20.35 must be satisfied at the inception of the covered bond and throughout its remaining maturity.

Disclosure requirements

Exposures in the form of covered bonds are eligible for the treatment set out in CRE20.38, provided that the bank investing in the covered bonds can demonstrate to its national supervisors that:

Covered bonds that meet the criteria set out in the CRE20.34 to CRE20.37 shall be risk-weighted based on the issue-specific rating or the issuer’s risk weight according to the rules outlined in CRE21.1 to CRE21.21. For covered bonds with issue-specific ratings,17 the risk weight shall be determined according to Table 8. For unrated covered bonds, the risk weight would be inferred from the issuer’s ECRA or SCRA risk weight according to Table 9.

Banks must perform due diligence to ensure that the external ratings appropriately and conservatively reflect the creditworthiness of the covered bond and the issuing bank. If the due diligence analysis reflects higher risk characteristics than that implied by the external rating bucket of the exposure (ie AAA to AA–; A+ to A– etc), the bank must assign a risk weight at least one bucket higher than the "base" risk weight determined by the external rating. Due diligence analysis must never result in the application of a lower risk weight than that determined by the external rating.

Exposures to securities firms and other financial institutions

Exposures to securities firms and other financial institutions will be treated as exposures to banks provided that these firms are subject to prudential standards and a level of supervision equivalent to those applied to banks (including capital and liquidity requirements). National supervisors should determine whether the regulatory and supervisory framework governing securities firms and other financial institutions in their own jurisdictions is equivalent to that which is applied to banks in their own jurisdictions. Where the regulatory and supervisory framework governing securities firms and other financial institutions is determined to be equivalent to that applied to banks in a jurisdiction, other national supervisors may allow their banks to risk weight such exposures to securities firms and other financial institutions as exposures to banks. Exposures to all other securities firms and financial institutions will be treated as exposures to corporates.

Exposures to corporates

For the purposes of calculating capital requirements, exposures to corporates include exposures (loans, bonds, receivables, etc) to incorporated entities, associations, partnerships, proprietorships, trusts, funds and other entities with similar characteristics, except those which qualify for one of the other exposure classes. The treatment associated with subordinated debt and equities of these counterparties is addressed in CRE20.53 to CRE20.62. The corporate exposure class includes exposures to insurance companies and other financial corporates that do not meet the definitions of exposures to banks, or securities firms and other financial institutions, as determined in CRE20.16 and CRE20.40 respectively. The corporate exposure class does not include exposures to individuals. The corporate exposure class differentiates between the following subcategories:

General corporate exposures

For corporate exposures of banks incorporated in jurisdictions that allow the use of external ratings for regulatory purposes, banks will assign "base" risk weights according to Table 10.18 Banks must perform due diligence to ensure that the external ratings appropriately and conservatively reflect the creditworthiness of the counterparties. Banks which have assigned risk weights to their rated bank exposures based on CRE20.18 must assign risk weights for all their corporate exposures according to Table 10. If the due diligence analysis reflects higher risk characteristics than that implied by the external rating bucket of the exposure (ie AAA to AA–; A+ to A– etc), the bank must assign a risk weight at least one bucket higher than the "base" risk weight determined by the external rating. Due diligence analysis must never result in the application of a lower risk weight than that determined by the external rating.

Unrated corporate exposures of banks incorporated in jurisdictions that allow the use of external ratings for regulatory purposes will receive a 100% risk weight, with the exception of unrated exposures to corporate small or medium-sized entities (SMEs), as described in CRE20.47.

For corporate exposures of banks incorporated in jurisdictions that do not allow the use of external ratings for regulatory purposes, banks will assign a 100% risk weight to all corporate exposures, with the exception of:

Banks must apply the treatment set out in CRE20.44 to their corporate exposures if they have assigned risk weights to their rated bank exposures based on CRE20.21.

Banks in jurisdictions that do not allow the use of external ratings for regulatory purposes may assign a 65% risk weight to exposures to "investment grade" corporates. An "investment grade" corporate is a corporate entity that has adequate capacity to meet its financial commitments in a timely manner and its ability to do so is assessed to be robust against adverse changes in the economic cycle and business conditions. When making this determination, the bank should assess the corporate entity against the investment grade definition taking into account the complexity of its business model, performance against industry and peers, and risks posed by the entity's operating environment. Moreover, the corporate entity (or its parent company) must have securities outstanding on a recognised securities exchange.

Corporate SMEs are defined as corporate exposures where the reported annual sales for the consolidated group of which the corporate counterparty is a part is less than or equal to €50 million for the most recent financial year. In some jurisdictions (eg emerging economies), national supervisors might deem it appropriate to define SMEs in a more conservative manner (ie with a lower level of sales). For unrated exposures to corporate SMEs in jurisdictions that allow the use of external ratings for regulatory purposes, and for all exposures to corporate SMEs in jurisdictions that do not allow the use of external ratings for regulatory purposes, an 85% risk weight will be applied. Exposures to SMEs that meet the criteria in CRE20.65(1) to CRE20.65(3) will be treated as regulatory retail SME exposures and risk weighted at 75%.

Specialised lending

A corporate exposure will be treated as a specialised lending exposure if such lending possesses some or all of the following characteristics, either in legal form or economic substance:

Exposures described in CRE20.48 will be classified in one of the following three subcategories of specialised lending:

Banks incorporated in jurisdictions that allow the use of external ratings for regulatory purposes will assign to their specialised lending exposures the risk weights determined by the issue-specific external ratings, if these are available, according to Table 10. Issuer ratings must not be used (ie CRE21.12 does not apply in the case of specialised lending exposures).

For specialised lending exposures for which an issue-specific external rating is not available, and for all specialised lending exposures of banks incorporated in jurisdictions that do not allow the use of external ratings for regulatory purposes, the following risk weights will apply:

A high quality project finance exposure refers to an exposure to a project finance entity that is able to meet its financial commitments in a timely manner and its ability to do so is assessed to be robust against adverse changes in the economic cycle and business conditions. The following conditions must also be met:

Subordinated debt, equity and other capital instruments

The treatment described in CRE20.57 to CRE20.60 applies to subordinated debt, equity and other regulatory capital instruments issued by either corporates or banks, provided that such instruments are not deducted from regulatory capital or risk-weighted at 250% according to CAP30, or risk weighted at 1250% according to CRE20.62. It also excludes equity investments in funds treated under CRE60.

Equity exposures are defined on the basis of the economic substance of the instrument. They include both direct and indirect ownership interests,20 whether voting or non-voting, in the assets and income of a commercial enterprise or of a financial institution that is not consolidated or deducted. An instrument is considered to be an equity exposure if it meets all of the following requirements:

In addition to instruments classified as equity as a result of paragraph CRE20.54, the following instruments must be categorised as an equity exposure:

Debt obligations and other securities, partnerships, derivatives or other vehicles structured with the intent of conveying the economic substance of equity ownership are considered an equity holding.22 This includes liabilities from which the return is linked to that of equities.23 Conversely, equity investments that are structured with the intent of conveying the economic substance of debt holdings or securitisation exposures would not be considered an equity holding.24

Banks will assign a risk weight of 400% to speculative unlisted equity exposures described in CRE20.58 and a risk weight of 250% to all other equity holdings, with the exception of those equity holdings referred to in CRE20.59.

Speculative unlisted equity exposures are defined as equity investments in unlisted companies that are invested for short-term resale purposes or are considered venture capital or similar investments which are subject to price volatility and are acquired in anticipation of significant future capital gains.25

National supervisors may allow banks to assign a risk weight of 100% to equity holdings made pursuant to national legislated programmes that provide significant subsidies for the investment to the bank and involve government oversight and restrictions on the equity investments. Such treatment can only be accorded to equity holdings up to an aggregate of 10% of the bank’s Total capital. Examples of restrictions are limitations on the size and types of businesses in which the bank is investing, allowable amounts of ownership interests, geographical location and other pertinent factors that limit the potential risk of the investment to the bank.

Banks will assign a risk weight of 150% to subordinated debt and capital instruments other than equities. Any liabilities that meet the definition of “other TLAC liabilities” in CAP30.3 to CAP30.5 and that are not deducted from regulatory capital are considered to be subordinated debt for the purposes of this paragraph.

Notwithstanding the risk weights specified in CRE20.57 to CRE20.60, the risk weight for investments in significant minority- or majority-owned and –controlled commercial entities depends upon the application of two materiality thresholds:

Investments in significant minority- or majority-owned and –controlled commercial entities below the materiality thresholds in CRE20.61 must be risk-weighted as specified in CRE20.54 to CRE20.60. Investments in excess of the materiality thresholds must be risk-weighted at 1250%.

Retail exposure class

The retail exposure class excludes exposures within the real estate exposure class. The retail exposure class includes the following types of exposures:

Exposures within the retail exposure class will be treated according to CRE20.65 to CRE20.67 below. For the purpose of determining risk weighted assets, the retail exposure class consists of the follow three sets of exposures:

“Regulatory retail” exposures are defined as retail exposures that meet all of the criteria listed below:

“Transactors” are obligors in relation to facilities such as credit cards and charge cards where the balance has been repaid in full at each scheduled repayment date for the previous 12 months. Obligors in relation to overdraft facilities would also be considered as transactors if there has been no drawdown over the previous 12 months.

“Other retail” exposures are defined as exposures to an individual person or persons that do not meet all of the regulatory retail criteria in CRE20.65.

The risk weights that apply to exposures in the retail asset class are as follows:

Real estate exposure class

Real estate is immovable property that is land, including agricultural land and forest, or anything treated as attached to land, in particular buildings, in contrast to being treated as movable/personal property. The real estate exposure asset class consists of:

“Regulatory real estate” exposures consist of:

Regulatory real estate exposures

For an exposure secured by real estate to be classified as a “regulatory real estate” exposure, the loan must meet the following requirements:

The risk weights for regulatory real estate exposures will apply to jurisdictions where structural factors result in sustainably low credit losses associated with the exposures to the real estate market. National supervisors should evaluate whether the risk weights in the corresponding risk weight tables are too low for these types of exposures in their jurisdictions based on default experience and other factors such as market price stability. Supervisors may require banks in their jurisdictions to increase these risk weights as appropriate.

National supervisors should ensure that banks put in place underwriting policies with respect to the granting of mortgage loans that include the assessment of the ability of the borrower to repay. Underwriting policies must define a metric(s) (such as the loan’s debt service coverage ratio) and specify its (their) corresponding relevant level(s) to conduct such assessment.30 Underwriting policies must also be appropriate when the repayment of the mortgage loan depends materially on the cash flows generated by the property, including relevant metrics (such as an occupancy rate of the property). National supervisors may provide guidance on appropriate definitions and levels for these metrics in their jurisdictions.

The LTV is the amount of the loan divided by the value of the property. When calculating the LTV, the loan amount will be reduced as the loan amortises. The value of the property will be maintained at the value measured at origination, with the following exceptions:

The LTV must be prudently calculated in accordance with the following requirements:

A guarantee or financial collateral may be recognised as a credit risk mitigant in relation to exposures secured by real estate if it qualifies as eligible collateral under the credit risk mitigation framework. This may include mortgage insurance35 if it meets the operational requirements of the credit risk mitigation framework for a guarantee. Banks may recognise these risk mitigants in calculating the exposure amount; however, the LTV bucket and risk weight to be applied to the exposure amount must be determined before the application of the appropriate credit risk mitigation technique.

Definition of “regulatory residential real estate” exposures

A “regulatory residential real estate” exposure is a regulatory real estate exposure that is secured by a property that has the nature of a dwelling and satisfies all applicable laws and regulations enabling the property to be occupied for housing purposes (ie residential property).36

Definition of “regulatory commercial real estate” exposures

A “regulatory commercial real estate” exposure is regulatory real estate exposure that is not a regulatory residential real estate exposure.

Definition of exposures that are “materially dependent on cash flows generated by the property”

Regulatory real estate exposures (both residential and commercial) are classified as exposures that are “materially dependent on cash flows generated by the property” when the prospects for servicing the loan materially depend on the cash flows generated by the property securing the loan rather than on the underlying capacity of the borrower to service the debt from other sources. The primary source of these cash flows would generally be lease or rental payments, or the sale of the property. The distinguishing characteristic of these exposures compared to other regulatory real estate exposures is that both the servicing of the loan and the prospects for recovery in the event of default depend materially on the cash flows generated by the property securing the exposure.

It is expected that the material dependence condition, set out in CRE20.79 above, would predominantly apply to loans to corporates, SMEs or SPVs, but is not restricted to those borrower types. As an example, a loan may be considered materially dependent if more than 50% of the income from the borrower used in the bank's assessment of its ability to service the loan is from cash flows generated by the residential property. National supervisors may provide further guidance setting out criteria on how material dependence should be assessed for specific exposure types.

As exceptions to the definition contained in CRE20.79 above, the following types of regulatory real estate exposures are not classified as exposures that are materially dependent on cash flows generated by the property:

Risk weights for regulatory residential real estate exposures that are not materially dependent on cash flows generated by the property

For regulatory residential real estate exposures that are not materially dependent on cash flow generated by the property, the risk weight to be assigned to the total exposure amount will be determined based on the exposure’s LTV ratio in Table 11 below. The use of the risk weights in Table 11 is referred to as the “whole loan” approach.

As an alternative to the whole loan approach for regulatory residential real estate exposures that are not materially dependent on cash flows generated by the property, jurisdictions may apply the “loan splitting” approach. Under the loan splitting approach, the risk weight of 20% is applied to the part of the exposure up to 55% of the property value and the risk weight of the counterparty (as prescribed in CRE20.89(1)) is applied to the residual exposure.37 Where there are liens on the property that are not held by the bank, the treatment is as follows:

Risk weights for regulatory residential real estate exposures that are materially dependent on cash flows generated by the property

For regulatory residential real estate exposures that are materially dependent on cash flows generated by the property, the risk weight to be assigned to the total exposure amount will be determined based on the exposure’s LTV ratio in Table 12 below.

Risk weights for regulatory commercial real estate exposures that are not materially dependent on cash flows generated by the property

For regulatory commercial real estate exposures that are not materially dependent on cash flow generated by the property, the risk weight to be assigned to the total exposure amount will be determined based on the exposure’s LTV in Table 13 below (which sets out a whole loan approach). The risk weight of the counterparty for the purposes of Table 13 below and CRE20.86 below is prescribed in CRE20.89(1).

As an alternative to the whole loan approach for regulatory commercial real estate exposures that are not materially dependent on cash flows generated by the property, jurisdictions may apply the “loan splitting” approach. Under the loan splitting approach, the risk weight of 60% or the risk weight of the counterparty, whichever is lower, is applied to the part of the exposure up to 55% of the property value38, and the risk weight of the counterparty is applied to the residual exposure.

Risk weights for regulatory commercial real estate exposures that are materially dependent on cash flows generated by the property

For regulatory commercial real estate exposures that are materially dependent on cash flows generated by the property39, the risk weight to be assigned to the total exposure amount will be determined based on the exposure’s LTV in Table 14 below. 40

Definition of “other real estate” exposures and applicable risk weights

An “other real estate” exposure is an exposure within the real estate asset class that is not a regulatory real estate exposure (as defined in CRE20.71 above) and is not a land ADC exposure (as defined in CRE20.90 below).

Other real estate exposures are risk weighted as follows:

Definition of land acquisition, development and construction exposures and applicable risk weights

Land ADC exposures41 refers to loans to companies or SPVs financing any of the land acquisition for development and construction purposes, or development and construction of any residential or commercial property. ADC exposures will be risk-weighted at 150%, unless they meet the criteria in CRE20.91.

ADC exposures to residential real estate may be risk weighted at 100%, provided that the following criteria are met:

Risk weight multiplier to certain exposures with currency mismatch

For unhedged retail and residential real estate exposures to individuals where the lending currency differs from the currency of the borrower’s source of income, banks will apply a 1.5 times multiplier to the applicable risk weight according to CRE20.63 to CRE20.68 and CRE20.82 to CRE20.84, subject to a maximum risk weight of 150%.

For the purposes of CRE20.92, an unhedged exposure refers to an exposure to a borrower that has no natural or financial hedge against the foreign exchange risk resulting from the currency mismatch between the currency of the borrower’s income and the currency of the loan. A natural hedge exists where the borrower, in its normal operating procedures, receives foreign currency income that matches the currency of a given loan (eg remittances, rental incomes, salaries). A financial hedge generally includes a legal contract with a financial institution (eg forward contract). For the purposes of application of the multiplier, only these natural or financial hedges are considered sufficient where they cover at least 90% of the loan instalment, regardless of the number of hedges.

Off-balance sheet items

Off-balance sheet items will be converted into credit exposure equivalents through the use of credit conversion factors (CCF). In the case of commitments, the committed but undrawn amount of the exposure would be multiplied by the CCF. For these purposes, commitment means any contractual arrangement that has been offered by the bank and accepted by the client to extend credit, purchase assets or issue credit substitutes.43 It includes any such arrangement that can be unconditionally cancelled by the bank at any time without prior notice to the obligor. It also includes any such arrangement that can be cancelled by the bank if the obligor fails to meet conditions set out in the facility documentation, including conditions that must be met by the obligor prior to any initial or subsequent drawdown under the arrangement. Counterparty risk weightings for over-the-counter (OTC) derivative transactions will not be subject to any specific ceiling.

A 100% CCF will be applied to the following items:

A 50% CCF will be applied to note issuance facilities and revolving underwriting facilities regardless of the maturity of the underlying facility.

A 50% CCF will be applied to certain transaction-related contingent items (eg performance bonds, bid bonds, warranties and standby letters of credit related to particular transactions).

A 40% CCF will be applied to commitments, regardless of the maturity of the underlying facility, unless they qualify for a lower CCF.

A 20% CCF will be applied to both the issuing and confirming banks of short-term self-liquidating trade letters of credit arising from the movement of goods (eg documentary credits collateralised by the underlying shipment). Short term in this context means with a maturity below one year.

A 10% CCF will be applied to commitments that are unconditionally cancellable at any time by the bank without prior notice, or that effectively provide for automatic cancellation due to deterioration in a borrower’s creditworthiness. National supervisors should evaluate various factors in the jurisdiction, which may constrain banks’ ability to cancel the commitment in practice, and consider applying a higher CCF to certain commitments as appropriate.

Where there is an undertaking to provide a commitment on an off-balance sheet item, banks are to apply the lower of the two applicable CCFs.46

Exposures that give rise to counterparty credit risk

For exposures that give rise to counterparty credit risk according to CRE51.4 (ie OTC derivatives, exchange-traded derivatives, long settlement transactions and securities financing transactions), the exposure amount to be used in the determination of RWA is to be calculated under the rules set out in CRE50 to CRE54.

Credit derivatives

A bank providing credit protection through a first-to-default or second-to-default credit derivative is subject to capital requirements on such instruments. For first-to-default credit derivatives, the risk weights of the assets included in the basket must be aggregated up to a maximum of 1250% and multiplied by the nominal amount of the protection provided by the credit derivative to obtain the risk-weighted asset amount. For second-to-default credit derivatives, the treatment is similar; however, in aggregating the risk weights, the asset with the lowest risk-weighted amount can be excluded from the calculation. This treatment applies respectively for nth-to-default credit derivatives, for which the n-1 assets with the lowest risk-weighted amounts can be excluded from the calculation.

Defaulted exposures

For risk-weighting purposes under the standardised approach, a defaulted exposure is defined as one that is past due for more than 90 days, or is an exposure to a defaulted borrower. A defaulted borrower is a borrower in respect of whom any of the following events have occurred:

For retail exposures, the definition of default can be applied at the level of a particular credit obligation, rather than at the level of the borrower. As such, default by a borrower on one obligation does not require a bank to treat all other obligations to the banking group as defaulted.

With the exception of residential real estate exposures treated under CRE20.107, the unsecured or unguaranteed portion of a defaulted exposure shall be risk-weighted net of specific provisions and partial write-offs as follows:

Defaulted residential real estate exposures where repayments do not materially depend on cash flows generated by the property securing the loan shall be risk-weighted net of specific provisions and partial write-offs at 100%. Guarantees or financial collateral which are eligible according to the credit risk mitigation framework might be taken into account in the calculation of the exposure in accordance with CRE20.76.

For the purpose of defining the secured or guaranteed portion of the defaulted exposure, eligible collateral and guarantees will be the same as for credit risk mitigation purposes (see CRE22).

Other assets

CAP30.32 specifies a deduction treatment for the following exposures: significant investments in the common shares of unconsolidated financial institutions, mortgage servicing rights, and deferred tax assets that arise from temporary differences. The exposures are deducted in the calculation of Common Equity Tier 1 if they exceed the thresholds set out in CAP30.32 and CAP30.33. A 250% risk weight applies to the amount of the three “threshold deduction” items listed in CAP30.32 that are not deducted by CAP30.32 or CAP30.33.

The standard risk weight for all other assets will be 100%, with the exception of the following exposures: