Basel IV: The new Credit Risk Standard Approach (CRSA)

In December 2015, the Basel Committee published its second consultative paper on the revision of the Credit Risk Standardised Approach (CRSA). The draft provides for a whole series of changes compared to the first consultative paper. The background for the revision of the CRSA is its high dependence on external ratings, lack of risk sensitivity as well as outdated calibration, lack of comparability and reconcilability with the IRBA asset classes. Furthermore, many national options as well as the partly high complexity, e.g. in the application of credit risk mitigation techniques (CRMT), have made the application and comparability difficult.

The applicability of external ratings has now not been abolished, as initially proposed, but adapted and supplemented by a so-called due diligence requirement. This obliges the institutions to validate external ratings internally before using them. Furthermore, the assignment of exposure classes was adjusted, simplifications of the CRM framework were made and national discretionary powers were reduced in order to achieve better comparability of the results.

The basic structure of the CRSA has been retained overall. The CRSA is to be applied by all banks, including users of internal models as a result of the floor regulations. The effect on capital requirements varies depending on the portfolio/business model.

Specifically, the exposure classes are aligned with the IRBA exposure classes and various risk weight ranges and calculation methods are adjusted. For example, for unrated institution exposures, this can result in a significant increase in risk weighting. Far-reaching changes are planned for the treatment of real estate financing. The risk weighting is to depend on a new form of loan-to-value ratio (LTV).

Furthermore, a distinction is to be made as to whether residential and commercial real estate loans depend on the creditworthiness of the borrower or the payment flow from the (rented) property itself with regard to repayment. Significantly higher risk weights than before apply to special financing. Preferential treatment of positions vis-à-vis small and medium-sized enterprises (SMEs) is also envisaged at the Basel level and is already being continued or even extended in Europe via the draft CRR II.

In addition, the credit conversion factors to be applied will be tightened compared to the current CRSA, risk weight surcharges for currency mismatches for unsecured positions will be introduced and the usability of internal haircut estimates in the application of CRMT will be prevented.

These changes pose a variety of challenges for banks. These range from the need to adapt systems and calculation methods with partly new data requirements to changed credit processes and capital requirements, which can also result from the effect of the capital floor.

In addition to an impact analysis for each individual institution, especially with regard to the changing capital requirements, an early gap analysis, especially with regard to necessary procedural adjustments, is also useful. Here, the implementation of due diligence requirements when using external ratings and the planning of the availability of the necessary data in the IT systems and possibly their subsequent entry (e.g. LTV) represent particular challenges. The strategic effects of changed capital requirements on products, customers and business areas, especially on real estate financing, interbank business, special financing, foreign currency and SME business, should also be considered at an early stage.