Basel Committee on Banking Supervision

Supervisors are responsible for assigning eligible ECAIs’ ratings to the risk weights available under the standardised approach to credit risk (CRE21.5). To promote a consistent mapping, this chapter provides guidelines to help supervisors to conduct such a process.

When supervisors assign an eligible ECAI’s credit risk assessments to the risk weights available under the standardised approach, they need to consider a variety of qualitative and quantitative factors to differentiate between the relative degrees of risk expressed by each assessment. Such qualitative factors could include the pool of issuers that each agency covers, the range of ratings that an agency assigns, each rating’s meaning, and each agency’s definition of default, among others.

Quantifiable parameters may help to promote a consistent mapping of credit risk assessments into the available risk weights under the standardised approach. The parameters presented below are intended to provide guidance to supervisors and are not intended to establish new or complement existing eligibility requirements for ECAIs.

To help ensure that a particular risk weight is appropriate for a particular credit risk assessment, supervisors should evaluate the CDR associated with all issues assigned the same credit risk rating. Supervisors may evaluate two separate measures of CDRs associated with each risk rating contained in the standardised approach, using in both cases the CDR measured over a three-year period.

1. For assessing long-run default experience over time, supervisors should evaluate the ten-year average of the three-year CDR when this depth of data is available.1 For new rating agencies or for those that have compiled less than ten years of default data, supervisors may ask rating agencies what they believe the 10-year average of the three-year CDR would be for each risk rating and hold them accountable for such an evaluation thereafter for the purpose of risk weighting the claims they rate.
2. The other measure that supervisors should consider is the most recent three-year CDR associated with each credit risk assessment of an ECAI.

Both measurements would be compared to aggregate, historical default rates of credit risk assessments (see Table 2).

As three-year CDR data is expected to be available from ECAIs, supervisors should be able to compare the default experience of a particular ECAI’s assessments with those issued by other rating agencies, in particular major agencies rating a similar population.

Mapping risk ratings to risk weights using CDRs

As guidance for the determination of the appropriate risk weights to which an ECAI’s risk ratings should be mapped, each of the CDR measures mentioned above is compared to the following reference and benchmark values of CDRs:

1. For each step in an ECAI’s rating scale, a ten-year average of the three-year CDR is compared to a long run “reference” three-year CDR representing the long-run international default experience of risk assessments.
2. Likewise, for each step in the ECAI’s rating scale, the two most recent three-year CDR are compared to “benchmarks” for CDRs. This comparison intends to determine whether the ECAI’s most recent record of assessing credit risk remains within the CDR supervisory benchmarks.

Table 1 below illustrates the overall framework for such comparisons.2

Comparing an ECAI’s long-run average three-year CDR to a long-run “reference” CDR

For each credit risk category used in the standardised approach of this framework, the corresponding long-run reference CDR provides information to supervisors on what its default experience has been internationally. The ten-year average of an eligible ECAI’s particular assessment is not expected to match exactly the long-run reference CDR. The long run CDRs are meant as guidance for supervisors, and not as “targets” that ECAIs would have to meet. The recommended long-run “reference” three-year CDRs for each of the Committee’s credit risk categories are presented in Table 2 below, based on the Committee’s observations of the default experience reported by major rating agencies internationally.

Comparing an ECAI’s most recent three-year CDR to CDR Benchmarks

Since an ECAI’s own CDRs are not intended to match the reference CDRs exactly, the following upper bounds of CDRs are considered acceptable for each assessment, and hence each risk weight, contained in the standardised approach.

The upper bounds for CDRs should serve as guidance for supervisors and not necessarily as mandatory requirements. Exceeding the upper bound for a CDR would therefore not necessarily require the supervisor to increase the risk weight associated with a particular assessment in all cases if the supervisor is convinced that the higher CDR results from some temporary cause other than weaker credit risk assessment standards.

To assist supervisors in interpreting whether a CDR falls within an acceptable range for a risk rating to qualify for a particular risk weight, two benchmarks are set for each assessment, namely a “monitoring” level benchmark and a “trigger” level benchmark (see Table 3).3

In all cases where the supervisor decides to leave the risk category unchanged, it may wish to rely on Pillar 2 SRP of this Framework and encourage banks to hold more capital temporarily or to establish higher reserves.

When the supervisor has increased the associated risk category, there would be the opportunity for the assessment to again map to the original risk category if the ECAI is able to demonstrate that its three-year CDR falls and remains below the monitoring level for two consecutive years.