As follow up to last post..Basel II accord this is one page I have selected out of the voluminous 130 page PDF that
appropriate because it balances the fact
that banking book positions likely could
not be easily or rapidly exited with the
possibility that in many cases a bank
can cover credit losses by raising
additional capital should the underlying
credit problems manifest themselves
gradually. The nominal confidence level
of the IRB risk-based capital formulas
(99.9 percent) means that if all the
assumptions in the IRB supervisory
model for credit risk were correct for a
bank, there would be less than a 0.1
percent probability that credit losses at
the bank in any year would exceed the
IRB risk-based capital requirement.5
As noted above, the supervisory
model of credit risk underlying the IRB
framework embodies specific
assumptions about the economic drivers
of portfolio credit risk at banks. As with
any modeling approach, these
assumptions represent simplifications of
very complex real-world phenomena
and, at best, are only an approximation
of the actual credit risks at any bank. To
the extent these assumptions (described
in greater detail below) do not
characterize a given bank precisely, the
actual confidence level implied by the
IRB risk-based capital formulas may
exceed or fall short of the framework’s
nominal 99.9 percent confidence level.
In combination with other
supervisory assumptions and
parameters underlying this proposal, the
IRB framework’s 99.9 percent nominal
confidence level reflects a judgmental
pooling of available information,
including supervisory experience. The
framework underlying this proposal
reflects a desire on the part of the
agencies to achieve (i) relative riskbased
capital requirements across
different assets that are broadly
consistent with maintaining at least an
investment grade rating (for example, at
least BBB) on the liabilities funding
those assets, even in periods of
economic adversity; and (ii) for the U.S.
banking system as a whole, aggregate
minimum regulatory capital
requirements that are not a material
reduction from the aggregate minimum
regulatory capital requirements under
the general risk-based capital rules.
A number of important explicit
generalizing assumptions and specific
parameters are built into the IRB
framework to make the framework
applicable to a range of banks and to
obtain tractable information for
calculating risk-based capital
requirements. Chief among the
assumptions embodied in the IRB
framework are: (i) Assumptions that a
bank’s credit portfolio is infinitely
granular; (ii) assumptions that loan
defaults at a bank are driven by a single,
systematic risk factor; (iii) assumptions
that systematic and non-systematic risk
factors are log-normal random variables;(not allowing for Fat tailed distributions that actually turn up in financial markets ed - JP)
and (iv) assumptions regarding(the correlation models absolutely can break down in Credit Default Swaps modeling and has also obviously happened in some CDO's and also in the Asset Backed Commercial Paper market... editorial note -- JP)
correlations among credit losses on
various types of assets.
The specific risk-based capital
formulas in this proposed rule require
the bank to estimate certain risk
parameters for its wholesale and retail
exposures, which the bank may do
using a variety of techniques. These risk
parameters are probability of default
(PD), expected loss given default
(ELGD), loss given default (LGD),
exposure at default (EAD), and, for
wholesale exposures, effective
remaining maturity (M). The risk-based
capital formulas into which the
estimated risk parameters are inserted
are simpler than the economic capital
methodologies typically employed by
banks (which often require complex
computer simulations). In particular, an
important property of the IRB risk-based
capital formulas is portfolio invariance.
That is, the risk-based capital
requirement for a particular exposure
generally does not depend on the other
exposures held by the bank. Like the
general risk-based capital rules, the total
credit risk capital requirement for a
bank’s wholesale and retail exposures is
the sum of the credit risk capital
requirements on individual wholesale
exposures and retail exposures.
The IRB risk-based capital formulas
contain supervisory asset value
correlation (AVC) factors, which have a
significant impact on the capital
requirements generated by the formulas.
The AVC assigned to a given portfolio
of exposures is an estimate of the degree
to which any unanticipated changes in
the financial conditions of the
underlying obligors of the exposures are
correlated (that is, would likely move
up and down together). High correlation
of exposures in a period of economic
downturn conditions is an area of
supervisory concern. For a portfolio of
exposures having the same risk
parameters, a larger AVC implies less
diversification within the portfolio,
greater overall systematic risk, and,
hence, a higher risk-based capital
requirement.6 For example, a 15 percent
AVC for a portfolio of residential
mortgage exposures would result in a
lower risk-based capital requirement
than a 20 percent AVC and a higher
risk-based capital requirement than a 10
percent AVC.
The AVCs that appear in the IRB riskbased
capital formulas for wholesale
exposures decline with increasing PD;
that is, the IRB risk-based capital
formulas generally imply that a group of
low-PD wholesale exposures are more
correlated than a group of high-PD
wholesale exposures. Thus, under the
proposed rule, a low-PD wholesale
exposure would have a higher relative
risk-based capital requirement than that
implied by its PD were the AVC in the
IRB risk-based capital formulas for
wholesale exposures fixed rather than a
function of PD. This inverse
relationship between PD and AVC for
wholesale exposures is broadly
consistent with empirical research
undertaken by G10 supervisors and
moderates the sensitivity of IRB riskbased
capital requirements for
wholesale exposures to the economic
cycle.
Question 1: The agencies seek
comment on and empirical analysis of
the appropriateness of the proposed
rule’s AVCs for wholesale exposures in
general and for various types of
wholesale exposures (for example,
commercial real estate exposures).
The AVCs included in the IRB riskbased
capital formulas for retail
exposures also reflect a combination of
supervisory judgment and empirical
evidence.7 However, the historical data
available for estimating these
correlations was more limited than was
the case with wholesale exposures,
particularly for non-mortgage retail
exposures. As a result, supervisory
judgment played a greater role.
Moreover, the flat 15 percent AVC for
residential mortgage exposures is based
largely on empirical analysis of
traditional long-term, fixed-rate
mortgages. Question 2: The agencies
seek comment on and empirical
analysis of the appropriateness and risk
sensitivity of the proposed rule’s AVC
for residential mortgage exposures—not
only for long-term, fixed-rate mortgages,
but also for adjustable-rate mortgages,
home equity lines of credit, and other
mortgage products—and for other retail
portfolios.
Another important conceptual
element of the IRB framework concerns
the treatment of EL. The ANPR
generally would have required banks to
hold capital against the measured
amount of UL plus EL over a one-year
horizon, except in the limited instance
of credit card exposures where future
--------------
55834 Federal Register / Vol. 71, No. 185 / Monday, September 25, 2006 / Proposed Rules
that's the actual page for those who want to peruse
----------------------------
it's an important report and it's not obvious that all countries will have all of their banks properly capitalized as the Basel II Accord standards are implemented all around the world.
forexhound.com
JOhn
occ.treas.gov |
