Basel Committee on Banking Supervision
International Convergence of Capital Measurement and Capital Standards
A Revised Framework - Updated November 2005
Instructions | About this Database
TABLE OF CONTENTS
Part 1 | Part 2 | Part 3 | Part 4 | Annex
Abbreviations.............................................................................................................. i
Introduction .............................................................................................................. 1
Part 1: Scope of Application ......................................................................................... 7
I. Introduction ...................................................................................................... 7
II. Banking, securities and other financial subsidiaries ................................... 7
III. Significant minority investments in banking, securities and other
financial entities ....................................................................................................8
IV. Insurance entities .................................................................................................. 8
V. Significant investments in commercial entities .................................................. 10
VI. Deduction of investments pursuant to this part ............................................... 10
Part 2: The First Pillar - Minimum Capital Requirements ......................................... 12
I. Calculation of minimum capital requirements .................................................... 12
A. Regulatory capital ............................................................................................ 12
B. Risk-weighted assets ......................................................................................... 12
C. Transitional arrangements ............................................................................. 13
II. Credit Risk ? The Standardised Approach .......................................................... 15
A. Individual claims ............................................................................................. 15
1. Claims on sovereigns ................................................................................. 15
2. Claims on non-central government public sector entities (PSEs) .......... 16
3. Claims on multilateral development banks (MDBs) .............................. 17
4. Claims on banks ......................................................................................... 17
5. Claims on securities firms ........................................................................... 19
6. Claims on corporates .................................................................................. 19
7. Claims included in the regulatory retail portfolios ................................ 19
8. Claims secured by residential property .................................................... 20
9. Claims secured by commercial real estate ................................................ 20
10. Past due loans ............................................................................................ 21
11. Higher-risk categories ............................................................................... 21
12. Other assets ............................................................................................... 22
13. Off-balance sheet items .............................................................................. 22
B. External credit assessments .............................................................................. 23
1. The recognition process .............................................................................23
2. Eligibility criteria ...................................................................................... 23
C. Implementation considerations ...................................................................... 24
1. The mapping process ............................................................................... 24
2. Multiple assessments ................................................................................ 24
3. Issuer versus issues assessment ............................................................. 24
4. Domestic currency and foreign currency assessments ....................... 25
5. Short-term/long-term assessments .......................................................... 25
6. Level of application of the assessment .................................................... 26
7. Unsolicited ratings ................................................................................... 26
D. The standardised approach - credit risk mitigation .................................... 27
1. Overarching issues ..................................................................................... 27
(i) Introduction .......................................................................................... 27
(ii) General remarks .................................................................................. 27
(iii) Legal certainty ...................................................................................... 27
2. Overview of Credit Risk Mitigation Techniques ................................. 28
(i) Collateralised transactions ................................................................... 28
(ii) On-balance sheet netting ..................................................................... 30
(iii) Guarantees and credit derivatives ....................................................30
(iv) Maturity mismatch ............................................................................. 31
(v) Miscellaneous ...................................................................................... 31
3. Collateral ..................................................................................................... 31
(i) Eligible financial collateral ................................................................. 31
(ii) The comprehensive approach ..............................................................32
(iii) The simple approach ...................................................................... 40
(iv) Collateralised OTC derivatives transactions .................................. 40
4. On-balance sheet netting ......................................................................... 41
5. Guarantees and credit derivatives ......................................................... 41
(i) Operational requirements ................................................................... 41
(ii) Range of eligible guarantors (counter-guarantors)/protection ...... 44
providers
(iii) Risk weights ....................................................................................... 44
(iv) Currency mismatches ....................................................................... 45
(v) Sovereign guarantees and counter-guarantees................................. 45
6. Maturity mismatches ................................................................................. 45
(i) Definition of maturity ......................................................................... 46
(ii) Risk weights for maturity mismatches .............................................. 46
7. Other items related to the treatment of CRM techniques ...................... 46
(i) Treatment of pools of CRM techniques .............................................. 46
(ii) First-to-default credit derivatives ...................................................... 47
(iii) Second-to-default credit derivatives ................................................. 47
III. Credit Risk - The Internal Ratings-Based Approach ....................................... 48
A. Overview ......................................................................................................... 48
B. Mechanics of the IRB Approach ...................................................................... 48
1. Categorisation of exposures ....................................................................... 48
(i) Definition of corporate exposures ........................................................ 49
(ii) Definition of sovereign exposures ........................................................ 51
(iii) Definition of bank exposures ................................................................ 51
(iv) Definition of retail exposures ................................................................ 51
(v) Definition of qualifying revolving retail exposures .............................. 52
(vi) Definition of equity exposures ............................................................ 53
(vii) Definition of eligible purchased receivables ....................................... 54
2. Foundation and advanced approaches ..................................................... 55
(i) Corporate, sovereign, and bank exposures ......................................... 56
(ii) Retail exposures .................................................................................. 56
(iii) Equity exposures .................................................................................. 56
(iv) Eligible purchased receivables ............................................................. 57
3. Adoption of the IRB approach across asset classes ................................. 57
4. Transition arrangements ........................................................................... 58
(i) Parallel calculation ............................................................................ 58
(ii) Corporate, sovereign, bank, and retail exposures ......................... 58
(iii) Equity exposures .................................................................................. 59
C. Rules for corporate, sovereign, and bank exposures .................................... 59
1. Risk-weighted assets for corporate, sovereign, and bank exposures .... 59
(i) Formula for derivation of risk-weighted assets ..................................... 59
(ii) Firm-size adjustment for small- and medium-sized entities (SME) .... 60
(iii) Risk weights for specialised lending .................................................... 60
2. Risk components ......................................................................................... 63
(i) Probability of default (PD) .................................................................... 63
(ii) Loss given default (LGD) ..................................................................... 63
(iii) Exposure at default (EAD) ................................................................... 69
(iv) Effective maturity (M) .......................................................................... 70
D. Rules for Retail Exposures .............................................................................. 72
1. Risk-weighted assets for retail exposures ............................................ 72
(i) Residential mortgage exposures ......................................................... 73
(ii) Qualifying revolving retail exposures ................................................... 73
(iii) Other retail exposures .......................................................................... 73
2. Risk components ...................................................................................... 74
(i) Probability of default (PD) and loss given default (LGD) ..................... 74
(ii) Recognition of guarantees and credit derivatives ................................ 74
(iii) Exposure at default (EAD) ................................................................... 74
E. Rules for Equity Exposures ............................................................................ 75
1. Risk-weighted assets for equity exposures .............................................. 75
(i) Market-based approach ....................................................................... 75
(ii) PD/LGD approach ................................................................................ 76
(iii) Exclusions to the market-based and PD/LGD approaches .................. 78
2. Risk components ........................................................................................ 78
F. Rules for Purchased Receivables .................................................................... 79
1. Risk-weighted assets for default risk ....................................................... 79
(i) Purchased retail receivables .................................................................... 79
(ii) Purchased corporate receivables .......................................................... 79
2. Risk-weighted assets for dilution risk ...................................................... 81
3. Treatment of purchase price discounts for receivables .......................... 81
4. Recognition of credit risk mitigants .......................................................... 82
G. Treatment of Expected Losses and Recognition of Provisions .................... 82
1. Calculation of expected losses ................................................................... 82
(i) Expected loss for exposures other than SL subject to the
supervisory slotting criteria .....................................................................82
(ii) Expected loss for SL exposures subject to the supervisory slotting
criteria .................................................................................................. 83
2. Calculation of provisions ........................................................................... 83
(i) Exposures subject to IRB approach ..................................................... 83
(ii) Portion of exposures subject to the standardised approach to credit
risk ....................................................................................................... 84
3. Treatment of EL and provisions ................................................................ 84
H. Minimum Requirements for IRB Approach ................................................. 84
1. Composition of minimum requirements ................................................. 85
2. Compliance with minimum requirements ............................................... 85
3. Rating system design ................................................................................. 86
(i) Rating dimensions ............................................................................... 86
(ii) Rating structure .................................................................................... 87
(iii) Rating criteria ....................................................................................... 88
(iv) Rating assignment horizon .................................................................. 89
(v) Use of models ...................................................................................... 89
(vi) Documentation of rating system design ............................................... 90
4. Risk rating system operations .................................................................... 90
(i) Coverage of ratings .............................................................................. 90
(ii) Integrity of rating process ..................................................................... 91
(iii) Overrides ............................................................................................. 91
(iv) Data maintenance ................................................................................ 91
(v) Stress tests used in assessment of capital adequacy ......................... 92
5. Corporate governance and oversight ........................................................ 93
(i) Corporate governance ......................................................................... 93
(ii) Credit risk control ................................................................................. 94
(iii) Internal and external audit ................................................................. 94
6. Use of internal ratings ................................................................................. 94
7. Risk quantification ..................................................................................... 95
(i) Overall requirements for estimation ..................................................... 95
(ii) Definition of default .............................................................................. 96
(iii) Re-ageing ............................................................................................. 97
(iv) Treatment of overdrafts ........................................................................ 97
(v) Definition of loss for all asset classes .................................................. 98
(vi) Requirements specific to PD estimation .............................................. 98
(vii) Requirements specific to own-LGD estimates ....................................99
(viii) Requirements specific to own-EAD estimates .................................100
(ix) Minimum requirements for assessing effect of guarantees and
credit derivatives ................................................................................... 102
(x) Requirements specific to estimating PD and LGD (or EL) for
qualifying purchased receivables ................................................................ 103
8. Validation of internal estimates ................................................................ 105
9. Supervisory LGD and EAD estimates ...................................................... 106
(i) Definition of eligibility of CRE and RRE as collateral ........................... 106
(ii) Operational requirements for eligible CRE/RRE .................................. 107
(iii) Requirements for recognition of financial receivables ..........................108
10. Requirements for recognition of leasing ................................................. 110
11. Calculation of capital charges for equity exposures .............................. 110
(i) The internal models market-based approach ....................................... 110
(ii) Capital charge and risk quantification .................................................. 111
(iii) Risk management process and controls .............................................. 113
(iv) Validation and documentation ............................................................ 113
12. Disclosure requirements ......................................................................... 115
IV. Credit Risk - Securitisation Framework .......................................................... 116
A. Scope and definitions of transactions covered under the securitisation
framework ........................................................................................................ 116
B. Definitions and general terminology............................................................... 116
1. Originating bank ......................................................................................... 116
2. Asset-backed commercial paper (ABCP) programme ............................. 117
3. Clean-up call ............................................................................................... 117
4. Credit enhancement .................................................................................... 117
5. Credit-enhancing interest-only strip ........................................................ 117
6. Early amortisation ....................................................................................... 117
7. Excess spread ............................................................................................. 118
8. Implicit support ............................................................................................ 118
9. Special purpose entity (SPE) ...................................................................... 118
C. Operational requirements for the recognition of risk transference ......... 118
1. Operational requirements for traditional securitisations ..................... 118
2. Operational requirements for synthetic securitisations ......................... 119
3. Operational requirements and treatment of clean-up calls ................... 120
D. Treatment of securitisation exposures ........................................................... 121
1. Calculation of capital requirements .......................................................... 121
(i) Deduction ............................................................................................. 121
(ii) Implicit support ..................................................................................... 121
2. Operational requirements for use of external credit assessments ........ 121
3. Standardised approach for securitisation exposures ............................ 122
(i) Scope.................................................................................................... 122
(ii) Risk weights ......................................................................................... 122
(iii) Exceptions to general treatment of unrated securitisation exposures ..123
(iv) Credit conversion factors for off-balance sheet exposures ................. 124
(v) Treatment of credit risk mitigation for securitisation exposures ........ 125
(vi) Capital requirement for early amortisation provisions ...................... 126
(vii) Determination of CCFs for controlled early amortisation features ....127
(viii) Determination of CCFs for non-controlled early amortisation features 128
4. Internal ratings-based approach for securitisation exposures ..............129
(i) Scope ................................................................................................... 129
(ii) Hierarchy of approaches ...................................................................... 130
(iii) Maximum capital requirement ..............................................................130
(iv) Ratings-Based Approach (RBA) .......................................................... 130
(v) Internal Assessment Approach (IAA) ................................................... 132
(vi) Supervisory Formula (SF) .................................................................... 135
(vii) Liquidity facilities.................................................................................. 138
(viii) Treatment of overlapping exposures ...................................................138
(ix) Eligible servicer cash advance facilities ............................................... 139
(x) Treatment of credit risk mitigation for securitisation exposures ........139
(xi) Capital requirement for early amortisation provisions ........................ 139
V. Operational Risk ..................................................................................................... 140
A. Definition of operational risk ......................................................................... 140
B. The measurement methodologies ................................................................... 140
1. The Basic Indicator Approach ................................................................... 140
2. The Standardised Approach ..................................................................... 142
3. Advanced Measurement Approaches (AMA) .......................................... 143
C. Qualifying criteria ............................................................................................ 144
1. The Standardised Approach ....................................................................... 144
2. Advanced Measurement Approaches (AMA) .......................................... 145
(i) General standards ................................................................................ 145
(ii) Qualitative standards ............................................................................ 146
(iii) Quantitative standards ......................................................................... 147
(iv) Risk mitigation....................................................................................... 151
D. Partial use........................................................................................................... 152
VI. Trading book issues .................................................................................................153
A. Definition of the trading book ..........................................................................153
B. Prudent valuation guidance ............................................................................ 155
1. Systems and controls ................................................................................. 155
2. Valuation methodologies ............................................................................ 155
(i) Marking to market ................................................................................ 155
(ii) Marking to model ................................................................................. 156
(iii) Independent price verification .............................................................. 156
3. Valuation adjustments or reserves .............................................................. 157
C. Treatment of counterparty credit risk in the trading book ......................... 157
D. Trading book capital treatment for specific risk under the standardised
methodology ......................................................................................................159
1. Specific risk capital charges for issuer risk ................................................. 159
2. Specific risk rules for unrated debt securities ............................................. 159
3. Specific risk rules for non-qualifying issuers ............................................... 160
4. Specific risk capital charges for positions hedged by credit derivatives ..... 160
Part 3: The Second Pillar - Supervisory Review Process ......................................... 162
I. Importance of supervisory review ........................................................................ 162
II. Four key principles of supervisory review ........................................................ 163
Principle 1 ........................................................................................................... 163
1. Board and senior management oversight ................................................. 163
2. Sound capital assessment .......................................................................... 164
3. Comprehensive assessment of risks ........................................................ 164
4. Monitoring and reporting ......................................................................... 166
5. Internal control review ............................................................................... 167
Principle 2 ........................................................................................................... 167
1. Review of adequacy of risk assessment ................................................. 168
2. Assessment of capital adequacy .............................................................. 168
3. Assessment of the control environment ................................................ 168
4. Supervisory review of compliance with minimum standards .......... 168
5. Supervisory response ............................................................................... 169
Principle 3 ........................................................................................................... 169
Principle 4 ........................................................................................................... 170
III. Specific issues to be addressed under the supervisory review process .......... 170
A. Interest rate risk in the banking book ........................................................... 170
B. Credit risk ........................................................................................................... 171
1. Stress tests under the IRB approaches .................................................... 171
2. Definition of default ................................................................................... 171
3. Residual risk ................................................................................................ 171
4. Credit concentration risk ........................................................................... 172
5. Counterparty credit risk ............................................................................. 173
C. Operational risk ........................................................................................... 175
D. Market risk ........................................................................................................ 175
1. Policies and procedures for trading book eligibility .............................. 175
2. Valuation ..................................................................................................... 176
3. Stress testing under the internal models approach ................................. 176
4. Specific risk modelling under the internal models approach ............... 176
IV. Other aspects of the supervisory review process ........................................... 177
A. Supervisory transparency and accountability ............................................ 177
B. Enhanced cross-border communication and cooperation ........................... 177
V. Supervisory review process for securitisation .................................................. 177
A. Significance of risk transfer ............................................................................ 178
B. Market innovations .......................................................................................... 179
C. Provision of implicit support ......................................................................... 179
D. Residual risks ................................................................................................... 180
E. Call provisions .................................................................................................. 180
F. Early amortisation ............................................................................................ 181
Part 4: The Third Pillar - Market Discipline .............................................................. 184
I. General considerations .......................................................................................... 184
A. Disclosure requirements ................................................................................ 184
B. Guiding principles .......................................................................................... 184
C. Achieving appropriate disclosure ................................................................. 184
D. Interaction with accounting disclosures ....................................................... 185
E. Materiality .......................................................................................................... 185
F. Frequency ........................................................................................................... 186
G. Proprietary and confidential information...................................................... 186
II. The disclosure requirements.................................................................................. 186
A. General disclosure principle.......................................................................... 187
B. Scope of application............................................................................................ 187
C. Capital .............................................................................................................. 188
D. Risk exposure and assessment ....................................................................... 189
1. General qualitative disclosure requirement........................................... 190
2. Credit risk..................................................................................................... 190
3. Market risk.................................................................................................... 198
4. Operational risk............................................................................................ 199
5. Equities ....................................................................................................... 200
6. Interest rate risk in the banking book ...................................................... 200
Annex
Annex 1: The 15% of Tier 1 Limit on Innovative Instruments ...........................................201
Annex 2: Standardised Approach ? Implementing the Mapping Process .........................202
Annex 3: Capital treatment for failed trades and non-DvP transactions ..........................206
Annex 4: Treatment of counterparty credit risk and cross-product netting ....................208
Annex 5: Illustrative IRB Risk Weights .............................................................................. 229
Annex 6: Supervisory Slotting Criteria for Specialised Lending................................. 231
Annex 7: Illustrative Examples: Calculating the Effect of Credit Risk Mitigation under
Supervisory Formula ............................................................................................... 250
Annex 8: Mapping of Business Lines........................................................................... 254
Annex 9: Detailed Loss Event Type Classification ....................................................... 257
Annex 10: Overview of Methodologies for the Capital Treatment of Transactions
secured by Financial Collateral under the Standardised and IRB Approaches... 259
Annex 11: The Simplified Standardised Approach ..................................................... 261
Part 1 | Part 2 | Part 3 | Part 4 | Annex
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