At a recent meeting held in Madrid, the Basle committee decided to comply with several of the suggestions set forth by an overwhelming majority of industry participants. The meeting was held to address the approximate 200 public responses Basle received on its third consultative paper (CP3).
At the Madrid meeting the committee agreed on the importance of finalizing the document, in an expedient manner that is both technically and prudentially sound, in an effort to provide banks with clear guidelines as they prepare to adopt the new accord. And although it has pushed back the deadline for the final draft - as it originally intended on releasing the final document by the end of this year - the committee expects to release the final sometime in 2004. Members maintained that this delay would not impact the 2006 implementation deadline.
Following the numerous industry suggestions submitted with regards to CP3, the committee agreed that it needed to simplify the treatment of asset securitizations. This includes eliminating the supervisory formula for calculating risk weights under the internal ratings-based (IRB) approach, and replacing by a less complex approach.
Beyond ABS specific rules
The committee aims to recalculate its treatment of expected versus unexpected losses. "It's an issue that has troubled banks that make risky' loans, such as credit cards, where portfolio yield more than covers the risk," explained analysts at BNP Paribas.
Standard & Poor's went as far as to announce that the rating agency might penalize institutions, radically reducing its capital calculated under the accords' proposed IRB approach (see 9/15/03). Under the standardized approach, risk weightings are calculated from credit ratings of borrowers. The IRB requires capital to be held according to the probability of default, while the advanced IRB approach allows banks to plug several factors into the formula to derive proper weightings.
The IRB approach produces a statistical measurement of both the unexpected losses and the expected losses that banks face in relation to their credit risk exposures. CP3 framework incorporated both expected and unexpected loss components into the IRB capital requirement, explained committee members.
After taking in hand the latest industry suggestions, the committee now believes that a separation of the treatment of unexpected and expected losses within the IRB approach would lead to a more consistent framework. "Under this modified approach, the measurement of risk-weighted assets (that is, the IRB capital requirement) would be based solely on the unexpected loss portion of the IRB calculations," the committee stated in a press release. "Accordingly, certain offsets within the IRB framework, in particular future margin income, would no longer be necessary."
However, members emphasized the importance of implementing a separate treatment of expected losses, thereby ensuring that banks adequately prepare against expected losses. "Under this separate treatment, banks will compare the IRB measurement of expected losses with the total amount of provisions that they have made, including both general and specific provisions," explained the committee. "For any individual bank, this comparison will produce a shortfall' if the expected loss amount exceeds the total provision amount, or an excess' if the total provision amount exceeds the expected loss amount."
The committee also intends to revise its approach regarding the treatment of credit card commitments as well as certain credit risk mitigation techniques. While the Madrid gathering may have concluded on an optimistic note, industry sources still believe that the many kinks that still exists may take a lot more time to iron out and added that it's doubtful the accord will move ahead within its intended timetable.