Introduction

This chapter presents the method of calculating the unexpected loss capital requirements for purchased receivables. For such assets, there are internal ratings-based (IRB) capital charges for both default risk and dilution risk.

Risk-weighted assets for default risk

For receivables belonging unambiguously to one asset class, the IRB risk weight for default risk is based on the risk-weight function applicable to that particular exposure type, as long as the bank can meet the qualification standards for this particular risk-weight function. For example, if banks cannot comply with the standards for qualifying revolving retail exposures (defined in CRE30.24), they should use the risk-weight function for other retail exposures. For hybrid pools containing mixtures of exposure types, if the purchasing bank cannot separate the exposures by type, the risk-weight function producing the highest capital requirements for the exposure types in the receivable pool applies.

For purchased retail receivables, a bank must meet the risk quantification standards for retail exposures but can utilise external and internal reference data to estimate the probabilities of default (PDs) and losses-given-default (LGDs). The estimates for PD and LGD (or expected loss, EL) must be calculated for the receivables on a stand-alone basis; that is, without regard to any assumption of recourse or guarantees from the seller or other parties.

For purchased corporate receivables the purchasing bank is expected to apply the existing IRB risk quantification standards for the bottom-up approach. However, for eligible purchased corporate receivables, and subject to supervisory permission, a bank may employ the following top-down procedure for calculating IRB risk weights for default risk:

Foundation IRB treatment

The risk weight under the foundation IRB treatment is determined as follows:

Advanced IRB treatment

Under the advanced IRB approach, if the purchasing bank can estimate either the pool’s default-weighted average loss rates given default (as defined in CRE36.83) or average PD in a reliable manner, the bank may estimate the other parameter based on an estimate of the expected long-run loss rate. The bank may: (i) use an appropriate PD estimate to infer the long-run default-weighted average loss rate given default; or (ii) use a long-run default-weighted average loss rate given default to infer the appropriate PD. In either case, the LGD used for the IRB capital calculation for purchased receivables cannot be less than the long-run default-weighted average loss rate given default and must be consistent with the concepts defined in CRE36.83. The risk weight for the purchased receivables will be determined using the bank’s estimated PD and LGD as inputs to the corporate risk-weight function. Similar to the foundation IRB treatment, EAD will be the amount outstanding minus K_Dilution. EAD for a revolving purchase facility will be the sum of the current amount of receivables purchased plus 40% of any undrawn purchase commitments minus K_Dilution (thus, banks using the advanced IRB approach will not be permitted to use their internal EAD estimates for undrawn purchase commitments).

For drawn amounts, M will equal the pool’s exposure-weighted average effective maturity (as defined in CRE32.44 to CRE32.55). This same value of M will also be used for undrawn amounts under a committed purchase facility provided the facility contains effective covenants, early amortisation triggers, or other features that protect the purchasing bank against a significant deterioration in the quality of the future receivables it is required to purchase over the facility’s term. Absent such effective protections, the M for undrawn amounts will be calculated as the sum of: (a) the longest-dated potential receivable under the purchase agreement; and (b) the remaining maturity of the purchase facility.

Risk-weighted assets for dilution risk

Dilution refers to the possibility that the receivable amount is reduced through cash or non-cash credits to the receivable’s obligor.2 For both corporate and retail receivables, unless the bank can demonstrate to its supervisor that the dilution risk for the purchasing bank is immaterial, the treatment of dilution risk must be the following:

This treatment will be applied regardless of whether the underlying receivables are corporate or retail exposures, and regardless of whether the risk weights for default risk are computed using the standard IRB treatments or, for corporate receivables, the top-down treatment described above.

Treatment of purchase price discounts for receivables

In many cases, the purchase price of receivables will reflect a discount (not to be confused with the discount concept defined in CRE32.29 and CRE32.62) that provides first loss protection for default losses, dilution losses or both. To the extent that a portion of such a purchase price discount may be refunded to the seller based on the performance of the receivables, the purchaser may recognise this refundable amount as first-loss protection and hence treat this exposure under the securitisation chapters of the credit risk standard CRE40 to CRE45, while the seller providing such a refundable purchase price discount must treat the refundable amount as a first-loss position under the securitisation chapters. Non-refundable purchase price discounts for receivables do not affect either the EL-provision calculation in CRE35 or the calculation of risk-weighted assets.

When collateral or partial guarantees obtained on receivables provide first loss protection (collectively referred to as mitigants in this paragraph), and these mitigants cover default losses, dilution losses, or both, they may also be treated as first loss protection under the securitisation chapters of the credit risk standard (see CRE44.10). When the same mitigant covers both default and dilution risk, banks using the Securitisation Internal Ratings-Based Approach (SEC-IRBA) that are able to calculate an exposure-weighted LGD must do so as defined in CRE44.21.

Recognition of credit risk mitigants

Credit risk mitigants will be recognised generally using the same type of framework as set forth in CRE32.21 to CRE32.28.3 In particular, a guarantee provided by the seller or a third party will be treated using the existing IRB rules for guarantees, regardless of whether the guarantee covers default risk, dilution risk, or both.