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This chapter sets out the calculation of risk-weighted assets for corporate, sovereign, bank and retail exposures.
Effective as of:
01 Jan 2023
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Last update:
27 Mar 2020
31.1
This chapter presents the calculation of risk weighted assets under the internal ratings-based (IRB) approach for: (i) corporate, sovereign and bank exposures; and (ii) retail exposures. Risk weighted assets are designed to address unexpected losses from exposures. The method of calculating expected losses, and for determining the difference between that measure and provisions, is described CRE35.
31.2
Regarding the risk-weight functions for deriving risk weighted assets set out in this chapter:
(1)
Probability of default (PD) and loss-given-default (LGD) are measured as decimals
(2)
Exposure at default (EAD) is measured as currency (eg euros), except where explicitly noted otherwise
(3)
ln denotes the natural logarithm
(4)
N(x) denotes the cumulative distribution function for a standard normal random variable (ie the probability that a normal random variable with mean zero and variance of one is less than or equal to x). The normal cumulative distribution function is, for example, available in Excel as the function NORMSDIST.
(5)
G(z) denotes the inverse cumulative distribution function for a standard normal random variable (ie the value of x such that N(x) = z). The inverse of the normal cumulative distribution function is, for example, available in Excel as the function NORMSINV.
31.3
The capital requirement (K) for a defaulted exposure is equal to the greater of zero and the difference between its LGD (described in CRE36.83) and the bank’s best estimate of expected loss (described in CRE36.86). The risk-weighted asset amount for the defaulted exposure is the product of K, 12.5, and the EAD.
31.4
The derivation of risk-weighted assets is dependent on estimates of the PD, LGD, EAD and, in some cases, effective maturity (M), for a given exposure.
31.5
For exposures not in default, the formula for calculating risk-weighted assets is as follows (illustrative risk weights are shown in CRE99):
31.7
A multiplier of 1.25 is applied to the correlation parameter of all exposures to financial institutions meeting the following criteria:
(1)
Regulated financial institutions whose total assets are greater than or equal to USD100 billion. The most recent audited financial statement of the parent company and consolidated subsidiaries must be used in order to determine asset size. For the purpose of this paragraph, a regulated financial institution is defined as a parent and its subsidiaries where any substantial legal entity in the consolidated group is supervised by a regulator that imposes prudential requirements consistent with international norms. These include, but are not limited to, prudentially regulated Insurance Companies, Broker/Dealers, Banks, Thrifts and Futures Commission Merchants.
(2)
Unregulated financial institutions, regardless of size. Unregulated financial institutions are, for the purposes of this paragraph, legal entities whose main business includes: the management of financial assets, lending, factoring, leasing, provision of credit enhancements, securitisation, investments, financial custody, central counterparty services, proprietary trading and other financial services activities identified by supervisors.
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31.8
Under the IRB approach for corporate credits, banks will be permitted to separately distinguish exposures to SME borrowers (defined as corporate exposures where the reported sales for the consolidated group of which the firm is a part is less than €50 million) from those to large firms. A firm-size adjustment (ie 0.04 x (1 – (S – 5) / 45)) is made to the corporate risk weight formula for exposures to SME borrowers. S is expressed as total annual sales in millions of euros with values of S falling in the range of equal to or less than €50 million or greater than or equal to €5 million. Reported sales of less than €5 million will be treated as if they were equivalent to €5 million for the purposes of the firm-size adjustment for SME borrowers.
31.9
Subject to national discretion, supervisors may allow banks, as a failsafe, to substitute total assets of the consolidated group for total sales in calculating the SME threshold and the firm-size adjustment. However, total assets should be used only when total sales are not a meaningful indicator of firm size.
31.10
Regarding project finance, object finance, commodities finance and income-producing real estate sub-asset classes of specialised lending (SL):
(1)
Banks that meet the requirements for the estimation of PD will be able to use the foundation IRB (F-IRB) approach for the corporate asset class to derive risk weights for SL sub-classes. As specified in CRE33.2, banks that do not meet the requirements for the estimation of PD will be required to use the supervisory slotting approach.
(2)
Banks that meet the requirements for the estimation of PD, LGD and EAD (where relevant) will be able to use the advanced IRB (A-IRB) approach for the corporate asset class to derive risk weights for SL sub-classes.
31.11
Regarding the high volatility commercial real estate (HVCRE) sub-asset class of specialised lending, banks that meet the requirements for the estimation of PD and whose supervisor has chosen to implement a foundation or advanced approach to HVCRE exposures will use the same formula for the derivation of risk weights that is used for other SL exposures, except that they will apply the following asset correlation formula:
31.12
Banks that do not meet the requirements for estimation of LGD or EAD for HVCRE exposures must use the supervisory parameters for LGD and EAD for corporate exposures, or use the supervisory slotting approach.
31.13
There are three separate risk-weight functions for retail exposures, as defined in CRE31.14 to CRE31.16. Risk weights for retail exposures are based on separate assessments of PD and LGD as inputs to the risk-weight functions. None of the three retail risk-weight functions contain the full maturity adjustment component that is present in the risk-weight function for exposures to banks, sovereigns and corporates. Illustrative risk weights are shown in CRE99.
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