Fitch Ratings Basel III Field Guide

Financial Institutions
Banks - Regulation
Global
Basel III Field Guide – Updated to Reflect Final “Endgame” Rules

A Primer for Bank Risk-Based Capital and Liquidity Requirements Contents
Introduction 2
What’s Changed (Since June 2019 Edition)
One Pager: Basel III Reform Summary 3
• Updated “One-Pager” tear-sheet summaries: Basel III Reform Summary (p2), Final
“Endgame” Impact Analysis (p3), Basel III Transition Timeline to reflect coronavirus-related Final Endgame Basel III: High-Level Impact Analysis 4
delay (p6) One Pager: Key Quantitative Requirements/Trip-Wires 5
• Extensive updates to the following “Primer” pages to reflect final Basel III revisions: Primer: Regulatory Capital 8
Minimum capital requirements for “core” bank risks (p9-13); External Bibliography (p24) Primer: Minimum Capital Requirements for “Core” Bank Risks 10
• Additional One-Pager style tear-sheet summaries of key risk-weightings under Revised Primer: Basel III Comparability Challenges 14
Standardised Approach to Credit Risk (p25) Primer: Securitisation Reforms 15
Primer: Pillar 2/Supervisory Review Process Regime 16
Primer: Interest-Rate Risk in the Banking Book (IRRBB) 17
Primer: Pillar 3 Disclosures/Market Discipline Regime 18
Primer: Basel III Capital Buffers 18
Primer: Basel III Leverage Ratio 20
Primer: Large Exposure Limits Regime 21
Primer: Liquidity Coverage Ratio 22
Primer: Liquidity Net Stable Funding Ratio 23
Annex 1: Basel III-Related External Bibliography 24
Annex 1: Basel III-Related External Bibliography (Cont) 25
Annex 2: Revised SA Credit Risk-Weightings 26
Annex 3: Regulatory Glossary 27
Annex 4: Pillar 1 Banking Book vs Trading Book Assignment – Reflecting Final Basel III “Endgame”
Revisions 30
Annex 5: Basel III Credit Risk Approaches – Reflecting Final Basel III “Endgame” Revisions 31
Annex 6: Basel III Credit Risk Mitigation – Reflecting Final “Endgame” Revisions 32
Annex 7: Basel III Revised Market Risk Framework – Standardised Approach Changes 33
Monsur Hussain
Financial Institutions Research
monsur.hussain@fitchratings.com
Special Report │ 12 November 2021 fitchratings.com 1

Banks - Regulation
Global
Introduction Impact of Basel III and “Basel IV” on Banks

Basel III requires banks to hold higher amounts of common equity Tier 1 (CET1) capital against risks
This field guide provides a high-level overview of the prudential regime applicable to internationally
generated from their activities than either Basel II or Basel 2.5. CET1-based capital buffers for
active banks (“Basel III”) and draws attention to the issues likely to be of relevance to debt (including
conservatism and to manage excess credit growth at a jurisdiction level were introduced. A mostly
hybrid debt) investors.
asset-based leverage ratio constraint applies, that ignores risk-weighted measures to guard against
Background model optimisation. A globally harmonised liquidity regime was also introduced.
The Basel Accords are issued by the Basel Committee on Banking Supervision (BCBS), a standing Significant revisions were published to the risk-weighted asset framework in December 2017,
committee of the Bank of International Settlements (BIS). They establish global minimum capital named “endgame” rules by authorities. The rules coming into effect by 1 January 2023 prohibit the
requirements for banks to cover risks arising from their financing and trading activities. While the use of internal models where it is felt risks cannot be reliably modelled – such as operational and
Basel Accords have no legal effect in jurisdictions, members of the BCBS are required to implement credit adjustment valuation risks. Existing standardised approaches (SAs) are overhauled to
prudential legislative regimes at least for internationally active banks that align to the Accords’ improve their risk sensitivity and robustness. And aggregate modelled requirements will be
principles. Most BCBS member countries and many non-BCBS member jurisdictions implement the permanently pegged to the revised SAs (the output floor). The leverage ratio constraint is
Basel Accords across the bank spectrum, for small domestic institutions as well as globally active supplemented with an additional Tier 1 (AT1)-based capital requirement for global-systemically
ones. Therefore, the BCBS is commonly considered to be the global standard-setter for the important banks (G-SIBs), alongside additional loss-absorbency requirements for the same.
prudential regulation of banks.
High Level Progression of Basel Accords
Membership of the BCBS is drawn from 27 member states, including the G20. The work of the BCBS
Capital
is ultimately overseen and approved by the Group of Governors and Heads of Supervision (GHOS), Requirements
comprising central bank governors and finance ministers from the 27 member states.
Overview: Basel Rule-Setting Cascade
BASEL III (2010+)
Bank for International Settlements (BIS) • + Higher common
equity tier 1 (CET1)
• Serves central banks in their pursuit of monetary and financial stability requirements
• Fosters international cooperation in those areas and to act as a bank for central banks • + CET1- based capital
buffers
BASEL I (1988) • + Leverage ratio
Group of Governors and Heads of Supervision (GHOS) Financial Stability Board • 8% minimum total
• + Liquidity ratios
BASEL 2.5 (2009)
• Central bank Governors/heads of supervision of 27 • Hosted by BIS (own capital ratio RWA Revisions (2017+)
• + Revised market risk • + Model constraints
GHOS member states legal identity) • Supervisory
BASEL II (2004-2006) rules for trading book
determined risk • + RWA “Output
• Oversees the Basel Committee on Banking Supervision • Coordinates national weightings • + More granular risk
risk positions
Floor”
(BCBS) financial authorities • No internal risk
weightings • + Revised
• + Standardised
Securitisation rules
and international models • + Internal models for approach revisions
standard-setting credit risk • + Leverage exposure
Basel Committee on Banking Supervision (BCBS)
• + Operational risk revision
• Global standard-setter for the prudential regulation of bodies work
capital
banks that provides a forum for cooperation on banking
supervisory matters. Mandate - to strengthen the Source: Fitch Ratings
regulation, supervision and practices of banks worldwide
with the purpose of enhancing financial stability. The Basel III changes are subject to comprehensive transitional arrangements over five years (see
• No authority to enforce recommendations page 7). Banks are required to disclose the various minimum capital requirement ratios, and risk-
weighted asset (RWA) adjustments that benefit from the transitional provisions.
Source: Fitch Ratings

Banks - Regulation
Global
One Pager: Basel III Reform Summary

Reforms/topics BCBS status Key requirements/changes Key implications Creditor impact
Regulatory capital Standard issued Dec 10; • Stricter definition of eligible capital, non-filtering of Other Comprehensive Income • Improved going-concern loss- • (+) Higher capital buffers;
implementation between • Doubling of CET1 requirement, increased deductions from CET1 absorbency, reduction in return on • (-) For AT1 holders,
To be potential review Jan 13 and Jan 19 • AT1 conversion/write-down based on CET1 trigger; simpler Tier 2 structure equity metrics uncertainty of regulatory
Under review, report in 1Q22 • Possible review of role of hybrid instruments, from coronavirus pandemic • Uncertainty regarding asset class driven embedded-call option
RWAs • CVA: final Jul 20, live Jan 23 • Credit valuation adjustment revisions broaden scope, eliminates use of models • Promotion of more risk-sensitive • (+) More conservative and
Significant changes • SA-CCR: live Jan 17 • Standardised Counterparty Credit Risk improves collateral and netting recognition standardised approaches in preference comparable RWAs, increased
• Securitisation: live Jan 19 • Securitisation regime increases RW floors, sensitivity of non-modelled approach to use of internal model approaches; capital buffer; mildly negative
• Market risk: updated Jan 19, go • Final market risk standards overhauls all approaches but especially the non-modelled simplification of approach options and for some loss of risk sensitivity
live Jan 23 approach, while setting a high bar for validating, approving models potential improved comparability regarding capital allocation on
• Credit/Op Risk: Final issued • Basel III revisions constrain internal risk models via input floors, no loss-given default across banks; more conservative RWAs assets
end-17, live Jan 23+ for large corp/FIs; Revised SA credit and op risk increase risk sensitivity
• Output (capital) floor: Final • Permanently restricts modelled capital requirements as 72.5% of hypothetical
issued end-17, live Jan 23+ standardised outcomes, per risk class. Five-year phase-in from Jan 2023
• Crypto assets proposal June 21 • Consults on 1250% risk weight to the maximum of long and short crypto positions • Disincentivises crypto holdings
Additional capital Final issued Dec 10; • Fulfilled via CET1, subject to limits on distributions if pierced: Capital conservation • Improved going-concern loss- • (+) Increased capital buffers
buffers implementation between buffer (CCB, 2.5% of RWAs) for prudency; countercyclical capital buffer (CcyB, 0%- absorbency, reduction in return on generally creditor positive;
Some changes; Jan 13 and Jan 19 2.5% RWA) as private credit growth extension of CCB equity metrics (ceteris paribus), less • (-) If buffers pierced,
• G-SIB buffer (1%-3.5% of RWAs), updated annually (domestic buffer discretionary) procyclical capital ratios constraints on hybrid debt
Potential changes • Under review, report in 1Q22 • Basel review on capital buffers may result in potential changes to buffer regime- in • Potential changes to buffer calibration distributions
light of banks’ hesitation to pierce capital buffers during the 2020-2021 pandemic
Leverage ratio • Ratio disclosure from Jan 15; • Global minimum 3% ratio (Tier 1 capital/leverage exposure) at consolidated entity • Blunt guard-rail against the • (+) Check against model risk,
Some changes live from Jan 18 • Revisions subject G-SIBs to AT1 buffer (50% of CET1-based buffer); change exposure “optimisation” of RWAs, increases leads to more conservative
• Revisions Dec 17, live Jan 23 definition (exempt true-sale securitisations, central bank reserves temporarily; capital carried on lower-risk assets (e.g. capital allocation
unsettled trade clarification; cash variation margining) cash, high-quality residential • (-) Incentivises high RWAs
mortgages/sovereign)
Liquidity regime LCR: Final issued Jan 13; • Short-term (30-day) liquidity coverage ratio (LCR) requires >100% ratio of high- • Incentivises the gathering of deposits, • (+) More robust liquidity
disclosures due from Jan 15 quality liquid assets (HQLA) during a 30-day stressed outflow longer-term wholesale funding, reduces • (-) Cost of funding and cost of
NSFR: Final issued Oct 14, • Longer-term (1-year) net stable funding requirement (NSFR) ratio requires >100% 1- short-term wholesale funding reliance. carry of high-quality liquid
disclosures due from Jan 18 year funding against stable funding requirements (regulatory capital and >1-year Increases desirability of high-quality assets
debt recognised as stable funding) liquid securities
Interest rate risk in the Basel standards issued Apr 16; • Retain Pillar 2 risk capture (vs Pillar 1 requirements), prescribed disclosures • Greater standardisation of behavioural • (+) Resilience from updated
banking book reporting and disclosures due • Six prescribed shock and stress scenarios, capture of credit spread risks and modelling assumptions, may level stresses and improved
from Jan 18 • Updated supervisory standards, use of standardised method as sanction playing field, increased comparability transparency/ comparability
Bank resolution/TLAC TLAC final standard Nov 15 Refer to Fitch Bank Resolution Primer • Refer to Fitch Bank Resolution Primer • (-) Increased burdensharing
Enhanced Pillar 3 Basel standards issued Jan 15; • Disclosures via fixed-form quantitative templates, more detailed tables • More granular fixed-form quantitative • (+) Improved transparency,
disclosures implementation by end-16; • Credit data more granular, increased frequency (up to quarterly vs annual) tables; more prescriptive qualitative comparability
Significant changes Consolidated templates issued • Draft guidelines published Jul 16 include new TLAC disclosure templates and disclosures; to be presented in one • (+) TLAC disclosures aid debt
Mar 17, updated Dec 18 increase scope of fixed-form templates; consolidates all Basel disclosures document loss and recovery analysis
• Updated December 2018 template reflects final Basel III reforms
Source: Fitch Ratings, Basel Committee for Banking Supervision, Financial Stability Board

Banks - Regulation
Global
Changes in Tier 1 MRC at the Target Level Due to the Final Basel III Standards
Final Endgame Basel III: High-Level Impact Analysis Groupe 1 Banks
The Basel Committee’s September 2021 monitoring report provides impact estimates of the final
Basel III “endgame” rules compared to the current (national rule-based) implementation. The survey Europe Americas Rest of the World
Per cent of overall basis MRC Per cent of overall basis MRC Per cent of overall basis MRC
of 178 banks (data as at end-December 2020) indicates the model input and output floor changes 109 109 109
most affect smaller banks with less than EUR3 billion of CET1 – so-called Group 2 banks, with a Tier 107 107 107
105 105 105
1 capital-based minimum required capital (MRC) average increase of 6.4% assuming fully phased-in 103 103 103
rules. This is much higher than the average 2.9% increase for the broader cohort of internationally 101 101 101
99 99 99
active banks with more than EUR3 billion in CET1 – the Group 1 banks, and the G-SIBs, who see an 97
97 97 95
average MRC increase of 3.5%, mainly from changes to the output floor and the leverage ratio. 95 95 93
93 93
CVA
Total
Market risk
Op risk
Other Pillar 1
Output Floor
Leverage Ratio
Credit Risk
From a regional perspective large European banks face the largest impact, with an average 17.6%
CVA
CVA
Total
Market risk
Op risk
Other Pillar 1
Total
Op risk
Output Floor
Leverage Ratio
Market risk
Output Floor
Credit Risk
Other Pillar 1
Leverage Ratio
Credit Risk
increase in MRC under the fully loaded final rules. Whereas banks from the rest of the world –
predominantly APAC – could see average MRC fall 5.8%. Large North American banks could see a
modest 2.5% increase in MRC.
Changes in Tier 1 MRC at the Target Level Due to the Final Basel III Standards Credit risk shows the change in MRC due to revised standardised and IRB approaches, including securitisation. Operational
risk figures may not show supervisor-imposed capital add-ons under Pillar 2. Therefore, increases in MRC may be overstated
Group 1 Banks Of which: GSIBs Group 2 Banks and reductions may be understated. Output floor results are net of the existing Basel-I based floor according to national
implementation of the Basel II framework.
Per cent of overall basis MRC Per cent of overall basis MRC Per cent of overall basis MRC
Source: Basel Committee on Banking Supervision
109 109 109
107 107 107
105 105 105 Notwithstanding the estimated impact analysis, evidence from previous Basel Accord reforms have
103 103 103 shown that banks adapt and alter their balance sheets in response to changes in capital
101 101 101
99 99 99 requirements. In addition, impact analyses are often hampered by a lack of precise data, that is more
97 97 97 likely to lead to overly conservative assumptions being applied.
95 95 95
93 93 93
Consequently, Fitch’s expectations are that the resulting impact from changes in the final endgame
CVA
Op risk
CVA
Op risk
Market risk
Market risk
Total
Total
Other Pillar 1
Other Pillar 1
Output Floor
Leverage Ratio
Output Floor
Leverage Ratio
Credit Risk
Credit Risk
CVA
Op risk
Market risk
Other Pillar 1
Total
Output Floor
Leverage Ratio
Credit Risk
capital standards will shrink further from the current implied estimates.
Credit risk shows the change in MRC due to revised standardised and IRB approaches, including securitisation. Operational
risk figures may not show supervisor-imposed capital add-ons under Pillar 2. Therefore, increases in MRC may be overstated
and reductions may be understated. Output floor results are net of the existing Basel I-based floor according to national
implementation of the Basel II framework.
Source: Basel Committee on Banking Supervision
The EU implementation of Basel rules is generally less conservative than elsewhere, and EU banks
rely more heavily reliant on models that are affected by the output floor restrictions (+7.3% MRC),
and the new operational risk approach (+4.0%). The regional divergence also reflects a structural
difference in the quantum of low-risk assets held by European banks versus their US peers. US banks
are also already subject to a more conservative 100% output floor requirement, that would see
MRC fall by 1.9% were the rules to be adopted. Large banks elsewhere are not as heavily affected
by the output floor, as average portfolio risk-weight densities are higher than for European banks.

Banks - Regulation
Global
One Pager: Key Quantitative Requirements/Trip-Wires Key RWA-Based Requirements

1. Minimum CET1 ratio: a component of the “minimum capital ratio”. Fully binding as of 2015.
There are broadly two types of quantitative trip-wires that banks need to adhere to: those that
relate to RWAs and those that do not (see page 7 for a global transitional schedule).
Minimum CET1 CET1
Key Non-RWA-Based Requirements = ≥ 4.5%*
Ratio RWA
• Liquidity Coverage Ratio: A short-term (30-day) metric assuming a shutdown of wholesale *excl. capital buffers: capital conservation, countercyclical, G-SIB, SRB
funding markets, and stressed outflows. Binding since 2019.
2. Minimum total capital ratio: no change from Basel I/II bar its composition. Binding since
2013.
Liquidity
High Quality Liquid Assets (HQLA)
Coverage Ratio = ≥ 100%
Net Cash Outflows: 30 Days Minimum Capital CET 1 + AT1 [Tier 1] + Tier 2
(LCR) = ≥ 8%*
Ratio RWA
• Net Stable Funding Ratio: A longer-term (one-year) liquidity metric that considers the
structural funding of balance-sheet assets via regulatory own funds and liabilities of at least 3. Minimum capital buffers ratio: sums minimum CET1, capital conservation, countercyclical
one-year tenor. A binding requirement since 2018. and SIB buffers. Binding since 2019.
CET1 ≥ 7% - 9.5%*
Net Stable Minimum Capital
(1yr) Available Stable Funding Buffers Ratio = RWA (G-SIB-
Funding Ratio = ≥ 100% 10.5%-13%)
(1yr) Required Stable Funding • Fully-loaded, 4.5% Pillar 1, 2.5% capital conservation, max 2.5% countercyclical buffer
(NSFR) • G-SIB buffer range from 1% to max 3.5%
• Leverage Ratio (LR): A Tier 1 capital-based balance-sheet constraint. Binding since 2018. 4. Total loss absorbing capacity (TLAC) Ratio: sets two regulatory minima. Phased in from
2019, taking full effect as of 2022.
Leverage =
Tier 1 Capital
= ≥ 3%+ Min Total Loss ≥ 6% -6.75%
Ratio (LR) On/Off-BS assets + Deriv + Sold CDS CET1 + AT1 + T2 + Qual. Debt
Absorbing Capacity = Leverage Ratio
Ratio (TLAC) 16-18% RWAs*
+ Systemically-important banks may be subject to additional buffers/numerator criteria Denominator
*excl. capital buffers: capital conservation, countercyclical, G-SIB, SRB
• Large Exposure (LE) Limit: Sets prudential single-name/group concentration limits. Changes
to the regime took effect since 2019 (change to numerator and G-SIB limit). 5. Additional Tier 1 Point of Non-Viability Trigger: quantifies the latest point at which an AT1
instrument would need to be written down or convert into CET1. Binding since 2013.
Large Exposure Tier 1 + min (Tier 2, 1/3 Tier 1)

= Ctpty or Group Exposure (in-scope assets + CCR + _ 25%
< AT1 Point of Non- CET 1
(LE) Limit Viability Trigger = ≥ 5.125%x
RWA
Trading Book Net position) - Risk Mitigation (PONV) x Assuming Total Capital , Pillar 2 AT1/T2 requirements met

Banks - Regulation
Global
“Fully Loaded” International Basel III Capital (Numerator) Requirements

(%) BCBS US G-SIBs EU Swiss G-SIBs India China Hong Kong Singapore Australia Japan
Min CET1 ratio 4.5 4.5 4.5 4.5 5.5 5.0 4.5 4.5 4.5 4.5
Implied AT1 ratioa 1.5 1.5 1.5 4.3 1.5 1.0 1.5 1.5 1.5 1.5
Implied Tier 2 ratio 2.0 2.0 2.0 2.0 2.0 2.0 2.0 2.0 2.0
Capital conservation buffer 2.5 2.5 2.5 5.5a 2.5b 2.5 2.5 2.5 2.5 2.5
D/G-SIB buffer 1-3.5 1-4.5 1-3.5 0.2-1.0 0.25c -3.25 3.5 2.0 1.0 1-3.5
Countercyclical buffer 0-2.5 0-2.5 0-2.5 0-2.5 0-2.5 0-2.5 0-2.5 0- 2.5 0-2.5 0-2.5
Total 16.5 17.5 16.5 16.8 15.0 14.0 16.5 15 14.0 16.5
a
5.5% CET1 going-concern buffer for Swiss G-SIBs is there to meet both capital conservation and G-SIB buffers
b
RBI extended implementation of final tranche of capital conservation buffer of 0.625% until 1 October 2021, due to the pandemic
c
Chinese D-SIB requirements start at 0.25% CET1, to 1.5%
Source: Fitch Ratings; BCBS jurisdiction implementation assessment reports
Fully-Loaded (2019) Capital Requirements, for Select International Jurisdictions
(%) Min CET1 ratio Implied AT1 ratioᵃ Implied T2 ratio Capital conservation buffer D/G-SIB buffer Countercyclical buffer
20
15
10
0
BCBS US GSIBs EU Swiss GSIBs India China Hong Kong Singapore Australia Japan
a 5.5% CET1 going-concern buffer for Swiss G-SIBs is there to meet both capital conservation and G-SIB buffers
Source: Fitch Ratings, Basel Committee for Banking Supervision

Banks - Regulation
Global
One Pager: Basel III Transition Timeline/Effective Date of Finalised Reforms

2015 2016 2017 2018 2019
Capital
Leverage ratio Disclosure 1 January (Pillar 1)
Minimum CET1 ratio (%) 4.50
Capital conservation buffer (%) 0.625 1.25 1.875 2.50
G-SIB buffer (%) 0.25-0.875 0.5-1.75 0.75-2.625 1-3.5
Countercyclical capital buffer Reciprocity provisions phased in between Jan 2016 and end-2018 Full reciprocity
Phase-in deductions from CET1 (%) 40 60 80 100 100
Minimum Tier 1 ratio (%) 5.50 6
Minimum total capital ratio (%) 8
Capital instruments that no longer qualify Phased out by 2022
Liquidity
LCR (%) 60 70 80 90 100
NSFR 1 January
Large exposures 1 January
Risk-weighted framework
Capital requirements for equity investments in funds 1 January
Standardised approach for counterparty credit risk (SA-CCR) 1 January
Securitisation framework 1 January
Interim capital requirements for CCP exposures Effective
Final capital requirements for CCP exposures 1 January
Margin requirements for OTC derivatives
Margin requirements for OTC derivatives (initial margining) Phased in from 1 September 2016-1 September 2020
Margin requirements for OTC derivatives (variation margining) Phased in from 1 September 2016-1 March 2017
Pillar 3 revisions Year-end
Review: Fitch jurisdiction-specific transitional timelines for APAC, EU, US
Source: Fitch Ratings, A report to G20 leaders on implementation of the Basel III regulatory reforms (BIS, November 2015)
Basel III “Endgame” Transition Timeline/Effective Date of Finalised Reforms

2023 2024 2025 2026 2027 2028
Capital
Revisions to leverage ratio 1 January
Revisions to credit IRB framework 1 January
Option – sovereign supported bank ratings 1 January
Revisions to CVA framework 1 January
Revisions to operational risk framework 1 January
Output floor (%) 50 55 60 65 70 72.5
Option – RWA cap, application of output floor (%) 25 25 25 25 25 No cap
Pillar 3 revisions 1 January 1st reporting
Source: Fitch Ratings, Basel III: Finalising post-crisis reforms (December 2017); Press release - deferral of Basel III implementation to respond to Covid-19 (March 2020)

Banks - Regulation
Global
Primer: Regulatory Capital The “Three Pillars” Approach to Prudential Capital Supervision
The focus of the Basel regime is to ensure that banks hold sufficient regulatory capital to provide Pillar 1: Minimum Capital Pillar 2: Internal / External Pillar 3: Public Disclosure/
a cushion against severe and unexpected losses arising from key risks generated from financing Requirements capital assessment Market Discipline
• Min 8% ratio- Reg • Bank undertakes “Internal • Requires banks to disclose
and trading activities (see below). Using a simple analogy of a car with depositors and creditors Capital/RWA Capital Adequacy key capital calculation
(such as bondholders) as passengers, regulatory capital acts as an airbag by mitigating the risk and ▪ Credit risk RWA Assessment Process” parameters in a consistent
impact of insolvency in the event of unexpected financial losses. ▪ Market risk RWA (ICAAP) to determine manner to aid
▪ Operational risk RWA adequacy of capital beyond comparability
Regulatory capital resources constitute (in broad terms) tangible common equity, hybrid • Calculated using rules minimum requirements • Allows market participants
instruments with features of equity and debt, and subordinated debt meeting certain qualifying framework to better assess bank
criteria. Expected losses are identified and incurred by provisions, and computed in line with • Firms using internal models • Supervisors evaluate how exposure to risks
generally accepted accounting practices. Expected credit loss (ECL) provisioning approaches have can use their own business a bank assesses its capital • Complements Pillars 1
applied via IFRS 9 standards since 2018, and FASB standards for US banks since 2020, which data and experience to needs (and take corrective and 2
require banks to assess credit loss expectations from day one of granting a loan. inform minimum capital actions if required)
requirements
Key Prudential Risks
Credit, market, operational risks at core of regulatory weighting Liquidity Risk – Liquidity Coverage Ratio (LCR)/Net Stable Funding Ratio (NSFR)
Element Risk description

Leverage Ratio (LR) – min 3% ratio
Credit risk Unilateral losses from the failure of a counterparty to meet credit obligations
when due (vs counterparty credit risk – bilateral risk of loss to either Source: Fitch Ratings
counterparty, depending on the market value of the trade at a point in time)
Market risk Risk of losses in on- and off-balance-sheet trading positions arising from
A core Basel principle is that a bank must at all times maintain regulatory capital (the numerator)
movements in market prices (mainly interest-rate risk in the banking book for equal to or greater than a percentage of its RWAs (the denominator). Banks and their regulators
non-traded exposures) determine capital adequacy needs using the “three pillars” approach, as set out above. Minimum
Operational risk Risk of losses resulting from inadequate or failed internal processes, people
capital requirements are held for Pillar 1 risks, plus additional Pillar 2 risks not captured under
and systems or from external events. Including legal risk (not exhaustive – Pillar 1 – interest-rate risk in the non-trading book, and concentration risks. Banks also have to
exposure to fines, penalties, or punitive damages resulting from supervisory abide by LR constraints and enhanced liquidity requirements.
actions as well as private settlements)
CVA risk Risk of potential market value losses on derivative transactions due to the Regulatory Capital Components
credit migration/default of the counterparty Common equity Tier1 Tier 1 capital Tier 2 capital
Liquidity risk Risk of not being able to meet short-term financial demands when due Common equity CET1 Instruments with min 5 years
IRRBB Risk that a bank will experience a deterioration in its financial position as original maturity (<5 years
interest rates move amortised)
Large exposures or Risk of incurring disproportionately large losses as a result of the default of Share premium account AT1 – non-cumulative perpetual Qualifying minority interest
concentration risk an individual client or group of connected counterparties due to unforeseen debt, write-down or CET1
events conversion trigger
Retained earnings Share premium account re AT1 Qualifying loan-loss reserves
Other risks (not exhaustive) Securitisation & off-balance-sheet, legal, reputational, strategic, pension
(e.g. preference shares
Source: Fitch Ratings AOCI Qualifying minority AT1 interests
Qualifying minority CET1 interests
Revaluation reserves
Source: Fitch Ratings, BCBS

Banks - Regulation
Global
Regulatory capital is split into two categories – Tier 1 and Tier 2 – depending on its ability to absorb Basel III Individual Deductions Thresholds
losses on a going-concern (Tier 1) or a gone-concern basis (Tier 2), alongside other characteristics DTAs, MSAs, FI equity inclusion in CET1 subject to 10%-15% CET1 tests
such as the degree of permanence of the eligible capital instrument.
Individual specified items 10% CET1 individual threshold 15% CET1 aggregate threshold
Regulatory Capital Deductions and Prudential Filters Mortgage servicing assets (MSAs) All items below 10% CET1 (after all If aggregate specified items are
Accounting equity and liabilities provide the starting point for the derivation of regulatory capital, DTAs arising from temporary deductions) are included in CET1 below 15% CET1 (after all
with various adjustments made to ensure its loss-absorbency qualities for prudential purposes. differences (and risk weight at 250%) deductions), then include in CET1
Basel III tightens the definition of regulatory capital by deducting more items from accounting Excess of each item above 10% (and risk-weight at 250%)
Significant investments in common
CET1 (after all deductions) are If aggregate amounts exceed 15%
liabilities than under Basel II, with most deductions taken directly from CET1, versus 50:50 from equity of unconsolidated financial
deducted from CET1 of CET1 (after all deductions),
both Tier 1 and Tier 2 under Basel II (see chart below). These changes in the definition of capital are institutions (direct, indirect,
deduct excess amounts from CET1
subject to the Basel III phase-in schedule. synthetic)
Derivation of Regulatory Capital From Accounting Liabilities
Accounting
Liabilities Goodwill Alongside the potential deduction of directly held capital instrument investments, Basel III requires
Defined banks to determine and possibly deduct net long positions in capital instruments held indirectly (e.g.
Deferred
benefit if a bank extends a secured loan to a special-purpose vehicle (SPV) whose sole assets comprise FI
Tax
pension equities), or synthetically via derivative positions (e.g. long call option on bank shares, or the variable
Assets Treasury/
fund assets Expected
and
insurance leg of a Total Return Swap referencing bank shares).
sub/ 3rd Loss
liabilities Threshold Shortfall/ Basel III reduces the extent accounting effects are neutralised – the so-called prudential filters – by
party FI
shares deductions Excess incorporating all accumulated other comprehensive income (AOCI) and other reserves into CET1
(FI investments, (IRB (e.g. unrealised gains or losses). Applying unrealised gains and losses to regulatory capital makes
DTAs, MSRs) banks) capital levels more volatile. For example, if interest rates rise, securities portfolios held at fair value
Regulatory
Capital will lose value and reduce CET1. However, accumulated net gains or losses on cash flow hedges are
not applied to CET1. Defined-benefit pension fund liabilities and assets are generally deducted from
CET1, as are any treasury shares (ie own issued shares held for remuneration distribution purposes).
Direct deductions of goodwill and other intangibles represent significant adjustments to financial
statements to determine regulatory capital, and are made solely to CET1. Importantly, Basel III does
not recognise deferred tax assets (DTAs) linked to future profitability as eligible CET1, and these
are deducted from CET1. Several other items have limited recognition as eligible capital under Basel
III (see below), which lead to deductions from bank CET1 versus Basel II.

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Primer: Minimum Capital Requirements for “Core” Bank Risks Basel III “Endgame” RWA Reforms – from January 2023
Upon the release of Basel III in 2010, the BCBS flagged that further revisions would be required to
Introduction improve risk sensitivity, comparability and reduce regulatory arbitrage. This has resulted in two key
Assets or exposures that are not deducted from regulatory capital are converted into RWAs, using policies: a sweeping revision of SAs; and constraints on the use of internal models, including a
either standardised (SA) or internal-model approaches (IMA, see below; refer to more detailed permanent capital floor – the output floor- that ties aggregated modelled and SA RWAs to 72.5% of
calculation process in Annexes 4-7). The RWA approaches were updated in December 2017 as part RWAs computed solely using the revised SAs.
of the Basel III “endgame” revisions (colloquially referred to as “Basel IV”, see right). The risk
granularity and sensitivity – particularly of SA – has been improved, and constraints on the use of Key Final Basel III Reforms
IMA apply. These amendments enter into force from January 2023, with the output floor phased in Solvency Framework (Minimum Regulatory Capital/Own Funds) FINAL – FROM 2023
over five years.
Sovereign
Credit Risk Market Risk Operational Risk OTC Exposure CVA Risk
Standardised vs Internal Model Approaches Risk
Current & to-be Basel III RWA elements, treatment options
FINAL FINAL- FINAL FINAL- FINAL Discussion
Element Book segment Standardised approaches Modelled approaches FROM1.1.23
FROM 1.1.23 FROM 1.1.23 FROM 1.1.17 FROM 1.1.23 Paper issued YE
Credit Risk (CR) Banking Standardised Approach (SA) Internal Ratings Based Basic 2017
(IRB) Indicator
Approach
Market Risk (MR) Trading Market Risk Standardised Internal Model TSA Current Simple
Approach (SA-TB) Approaches (IMA) SA SA Exposure
Revised Basic CVA
From 2023: New SA From 2023: New IMA Revised SA Revised Method
SA
SA SA-CCR SA-CVA
Operational Risk (OR) Banking/Trading Until end-2022: Basic Indicator Until end-2022: Advanced
Approach (BIA), or The Measurement Approach
Standardised Approach (TSA) (AMA)
From 2023: New SA (ORSA) From 2023: not permitted Internal Models Internal Models Advanced Internal Advanced/ End to 0% risk
FI, Large Corp, (VaR, ES, IRC, Measurement Model Model weights?
Counterparty Credit Risk Banking/Trading From 2017: Standardised Internal Model Method
Mid/Small Corp, CRM) Approach Method Approach Exemption
(CCR) – OTC derivatives Approach to CCR (SA-CCR, (IMM) SME, Retail from Large
implementation date varies) Exposures?
Counterparty Credit Risk Banking/Trading Financial Collateral Repo – VaR/Internal Permanent Capital Floor (Output Floor) to Internal Risk Models FINAL, FROM 2023-2028
(CCR) – Repos Comprehensive Method (FCCM) Haircuts
From 2023: Min haircut floors Leverage Ratio (LR) FROM 2018; EXPOSURE REVISIONS FROM 2023
Securitisation Banking External Rating-Based (SEC-ERBA, Internal Ratings-Based
if permitted), or (SEC-IRBA) Source: Fitch Ratings
Securitisation Standardised
Approach (SEC-SA) fallback The output floor is simple to apply and allows for offsetting of risks between different categories. It
is more impactful where banks use internal models for all or most risk categories, and where such
Credit Valuation Trading Until end-2022: Standardised Until end-2022: Advanced
Adjustment (CVA) approach approach modelled RWAs are much lower than the SA weightings. While the introduction of the output floor
After 2023: Standardised After 2023: not permitted may blunt the incentive to develop internal models, Fitch believes that the largest and more complex
approach (SA-CVA) banks will still be required by supervisory authorities to maintain and continue to develop models
Basic approach (BA-CVA) for their own risk management and pricing purposes. Also, the expected credit loss provisioning in
accounting standards will still require internal modelling approaches.
The Standardised/Non-Modelled Approaches to Calculate RWAs

By default, banks must use the SAs to determine RWAs. These approaches are based on prescriptive
rules, are easy to apply, and aid comparison between banks. But SAs are not as risk granular and

Banks - Regulation
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sensitive as IMAs, and in general do not reflect internal risk-management views (with only limited Sensitivity-based Standardised Approach for Market Risk in the Trading Book (SA-TB)
adjustments feasible).
RWA = 12.5* [ General Risk Capital Charge + Specific Risk Capital Charge ]
SA Credit Risk: Risk weights depend on exposure type and counterparty credit rating. Compared to
existing rules, the December 2017 revisions introduced more granular risk-weightings for claims
secured by real-estate and certain corporate and bank counterparties. The rules now require bank Net position (fair value) Net position (fair value)
credit ratings used for the external credit risk assessment (ECRA) approach to exclude implicit
government support, with an exception for policy-type banks owned by their respective Charge multiplier – varies by Charge multiplier – varies by
governments. This supports the broader G20 Financial Stability Board’s policy objective of risk type risk type
removing sovereign support for banks and ending “too big to fail”. National authorities will be E.g. Interest rate instruments- E.g. interest rate- issuer type,
allowed up to five years from 2023 to implement the change. maturity ladder vs. Price maturity, credit rating
sensitivity based on assumed
Revised Credit Risk Standardised – External Credit Risk Assessment (ECRA) changes in yield
RWA = Exposure at Default (EAD) x Risk Weight (RW) Source: Fitch Ratings
Derivative Exposure Methodologies: The standardised approach to counterparty credit risk (SA-
Drawn: Net of provisions/write-offs SA Exposure Class CCR) replaced the CEM approach in January 2017, and will also be used to determine derivative
exposure for LR purposes. SA-CCR incorporates improved recognition of collateral and the use of
Undrawn or Off-B/S: Nominal* Credit Ratings netting agreements compared with the CEM, so potentially benefits those banks with extensive
Conversion Factor (CF) netting and collateralisation arrangements.
Derivatives: OEM/CEM/IMM Standardised Approach to Counterparty Credit Risk (SA-CCR)
Source: Fitch Ratings SA-CCR
EAD
= 1.4* [ Replacement cost (RC) + Potential future exposure (PFE) ]
For unrated counterparties and jurisdictions, such as the US, that prohibit banks from using credit • Calculated for each regulatory • PFE for regulatory netting set
ratings for regulatory purposes, a non-credit-rating-based “standardised credit risk assessment” netting set determned as
(SCRA) approach has been introduced. There is also a risk-weighting add-on for lending in foreign • For non-margined transactions
currency. Capital charges for off-balance-sheet items increase, and changes are proposed for the PFE = multiplier * AddOnaggregate
risk-mitigation framework. RC = max (V – C, 0)
• Multliplier varies from 5%-100%.
Values < 100% are archieved in
SA Market Risk: Capital charges currently vary by underlying instrument and portfolio attributes • For margined transactions
case of over-collateralization, i.e.
(no diversification benefits between risk categories). The revised final market risk standard (from When V < C
RC = max (V – C, TH + MTA –
2023) defines a stricter boundary between the trading and banking book and varies the applicable NICA, 0) • Aggregate add-on equals sum of
liquidity horizons. This replaces the static 10-day horizon assumed for all traded instruments in the add-ons determined seperately
Where
current framework and mitigates the risk of a sudden and severe impairment of market liquidity for each asset class, comprising
across asset markets. V - sum of net mark-to-market • Interest rates
values of contracts in netting set • FX
The revised SA (SA-TB) is more risk sensitive than the outgoing SA, to better serve as a credible C - post-haircut collateral • Credit
fallback to the IMA. By incorporating diversification effects, the SA-TB levels the playing field with balance (incl. variation margin • Equity
exchanged so far) • Commodities
the IMA (the latter has had its existing diversification benefits curbed). But the SA-TB requires more
• Size of add-ons differs across
complex data inputs. Derivatives referencing hard-to-model market risks (such as “jump to default” TH - threshold amount
margines / non-margines
and “longevity” risks) will be subject to a residual risk add-on capital charge as a percentage of the NICA - net independent transactions
contract nominal. collateral amount

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Operational Risk (OR): Currently, banks have the option of using either a less sophisticated SA – ensure that banks’ capital requirements do not fall below a certain percentage of capital
the Basic Indicator Approach (BIA) – based on three years of positive average gross income as input requirements derived under the revised standardised approaches.
– or The Standardised Approach (TSA) – which uses a slightly more granular calculation, using the
Total RWAs must be calculated as the maximum of: (i) the total RWAs calculated using the approaches
gross income (as for BIA), as a three-year average of the simple sum of capital charges across each
that the bank has supervisory approval to use in accordance with the Basel capital framework
of the business lines. But from 2023, all approaches will be replaced by the Operational Risk
(including both SA and IMA); and (ii) 72.5% of the total RWAs, calculated using only the SA. For
Standardised Approach (ORSA).
example, assuming a bank has pre-floor RWAs of 76, and SA RWAs of 140, as the floored RWA of 101.5
Operational Risk Standardised Approach (ORSA) is higher than the pre-floor RWA (76 in this example), the bank would use 101.5 to determine its
minimum capital requirements (and prudential capital ratio calculations).
Marginal Coefficient ] Internal Loss
Capital = [ Business Indicator (BI) * (αi) * Multiplier (ILM) IRB Credit Risk: The internal ratings-based (IRB) approach to credit risk estimates the amount of
unexpected losses that could exceed Tier 1 and Tier 2 capital on average once every 1,000 years,
over a 12-month horizon (refer to BCBS explanatory note). Key risk weight inputs are probability of
Interest/lease/dividend Depending on BI N/A if BI<EUR1bn, default (PD), loss-given default (LGD) and conversion factors (CF) for off-balance-sheet positions
Income (12%, 15%, 18%) national discretion
(refer to Annex 5 for more details of approaches per asset class).
Operating/Fee Income Internal Ratings-Based Approach (IRB), Credit Risk

RWA = 1.06 * [ Exposure at Default (EAD) x Risk Weight (RW) ]
Net P&L Trading/Banking
The ORSA uses a “Business Indicator” (BI) as a financial statement-based proxy for operational risk, Drawn: Gross of provisions/ Exposure Class
multiplied by the Internal Loss Multiplier (ILM), a scaling factor based on a bank’s average historical write-offs
losses and the BIC. The use of the ILM is at national discretion. Therefore, if jurisdictions take Probability of Default (PD)
different decisions in terms of the ILM, then operational risk capital requirements will not be Undrawn or Off-B/S: Nominal *
comparable across firms/jurisdictions. Conversion Factor (CF) Loss Given Default (LGD)
The Internal Model Approaches Derivatives: OEM/CEM/IMM Maturity (M)

Banks use internal risk models as an alternative to, or alongside, the SA, contingent upon receiving Source: Fitch Ratings
supervisory approval. These approaches rely on banks’ own experience and data histories to
calculate RWAs, so resulting capital charges tend to align with banks’ internal view of risk. However, From 2023, however, modelled LGD estimates will not be allowed for credit risk to large corporates
IMAs require considerable resources to obtain supervisory approval of use, and governance and (>EUR500 million revenues) and FIs, after supervisory assessments highlighted unwarranted and
oversight requirements. unexplained variability. And model input floors and more conservative constraints will keep banks
from feeding their models with excessively low inputs as a safeguard preventing capital requirements
Basel III requires banks transitioning to modelled credit and/or operational risk approaches to be being set too low. For example, PDs for residential mortgages will go up from 3bp to 5bp.
subject to a time-limited capital floor (length varies by national discretion) based on 80% of
requirements calculated under the original Basel I framework (some national supervisors IMA Market Risk: Currently, value at risk (VaR) models are predominantly used to estimate the risk
alternatively accept a capital floor based on the Basel II and III SA). of losses from general and specific price risk factors during a 10-day horizon exceeding a given
threshold once every 100 years (refer to Annex 7 for more information).
Constraints on the Use of Modelled Approaches from 2023: Use of IMAs will be scaled back where
regulators are not confident the risks can be measured and modelled accurately – so internal models In contrast to the present framework whereby banks apply for model approval at the legal entity
are no longer permitted for operational risk, CVAs, or banking book equities, and securitisations in level, from 2023 the final standard requires model approval at the level of individual trading desks,
the trading book. To reduce excessive variability of RWAs and to enhance the comparability of risk- and subject to more stringent criteria. By requiring IMA banks to report hypothetical SBA capital
weighted capital ratios, a permanent output floor will be phased in over five years from 2023, to requirements in parallel, this allows supervisors to consider switching the use of IMA models on or

Banks - Regulation
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Internal Models Approach (IMA) – Market Risk

off for specific bank desks if tougher model validation standards are not being met, without affecting
other desks or business lines. = x Effective Expected Positive
EAD Alpha (floor=1.2)
Exposure (EEPE)
VaR models that enable risk managers to ask “how bad can things get?” are replaced by stressed
expected shortfall (ES) models, which allow managers to enquire “if things get bad, what is our
expected loss?”. In addition, securitisation products are now fully excluded from IMA and must Adjustment for correlations Scenario generation
therefore be calculated using the SBA. effects, potential lack of
granularity, and offset model Revaluation of marks
Stressed Expected Shortfall (ES) error or estimation error
Trading book risk positions/instruments (including trading book Netting/collateral

securitisations)
Compute measures
Default/ Sec Risks
Modellable
Migration Correlation Not In
Risk Factors
Risks Portfolio VaR
The Advanced Measurement Approach (AMA)- Operational Risk (discontinued)
Compre- Historic External Forward-

Modellable Default Internal
hensive Op Risk Loss Op risk loss looking
RNIV Control Factors
RWA = 12.5* [ Risk Factors Risk
Risk ] data data scenarios
(VaR/SVaR (IRC) (add-on)
Measure
Models) Model
Model
RWA = 12.5* [ Regulatory capital requirement calculation ]
Diversification benefits allowed (so capital charge is not simple sum

of these components) Source: Fitch Ratings

The lack of modelling standards within the Basel text, and the uncertainty associated with estimates
IMM for Derivatives: For derivative exposures, the internal model method (IMM) significantly of the 99.9% percentile of the annual operational loss distribution has led to approaches that are
departs from CEM and SA-CCR. It relies on simulating (thousands of times per position), the seen by many regulators and industry practitioners as unnecessarily complex, lacks comparability
potential positive exposure paths of a trade to ultimately estimate exposure at default (EAD). across banks and jurisdictions, and potentially offering banks opportunity to game capital
requirements.
Advanced Modelling Approach for Operational Risk: This approach allows a bank to calculate its
regulatory capital charge using internal models, based on internal risk variables and profiles, and not In light of the inherent complexity of modelling operational risk capital measures and the lack of
on exposure proxies such as gross income. comparability where banks use the AMA, from 2023 the AMA will be eliminated. Instead, all banks
will have to solely rely upon the ORSA.
The AMA requires banks to estimate the 99.9th percentile of the annual operational loss
distribution. But the Basel text is silent on how this estimation should take place and, thus, in theory
banks are provided full flexibility. Banks are required to use internal loss data, external loss data,
scenario analysis, and business environment and internal control factors in their operational risk
measurement system, but the BCBS did not set standards defining how these data elements should
be combined.

Banks - Regulation
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amortised cost will generate less equity volatility, unless the loan is impaired. Aggressive accounting
Primer: Basel III Comparability Challenges practices can increase fair values or recognise impairment later, thus overstating equity and
The key to comparing Basel III capital ratios across banks in different jurisdictions is to identify and regulatory capital earlier on. Total capital ratios may vary due to the type of provisions booked.
reconcile potential sources of variability in ratios and, in turn, to consider differences in risk
estimation. Key barriers to comparability arise from the following sources: Choice of RWA Approach
The calibration of the numerous RWA approaches varies by design, and by a bank’s implementation
1. National implementation of Basel regime
of the internal model, meaning that the same portfolio or risk exposure typically generates different
2. Accounting practices capital charges depending on the approach used. The IRB credit risk weights are highly granular and
sensitive to discrete variations in PD and LGD; by comparison, the SA credit risk slots assets into
3. Choice of RWA approach
broader risk-weight buckets. High quality corporate and residential mortgage assets assessed
4. Asset classification and segmentation under the IRB credit risk approach are calibrated to output lower charges than under the SA.
Conversely, IRB capital charges tend to exceed SA capital charges on sub-investment-grade assets.
National Implementation of Basel Regime There are variations between the collateral and risk mitigation approaches (see Annex 6), that can
By design, the Basel standards incorporate many national discretions, allowing countries to adapt result in different capital charges for a given transaction.
the international standards to reflect jurisdictional differences in the structure and relative stage of
development of their financial or legal systems. For example, in the US banks are not permitted to
Asset Classification and Segmentation
use credit ratings (to map to risk weights), so less granular fixed risk weights are used instead. In Basel risk-weighting treatment is generally differentiated by asset class and instrument type, and
other countries, bank counterparties weights may be notched down relative to the sovereign credit varies by assignment to the trading book versus the non-trading (banking) book. High-level rules set
rating, instead of using the bank’s credit rating. For IRB credit risk, supervisors have the discretion out the key characteristics and definitions of these asset classes and the assignment between
to alter the definition of default, which can have a material impact on modelling outcomes between banking and trading books (see Annex 4 for an overview of the book assignment, including changes
banks for an otherwise identical portfolio. due to Basel III revisions, and Annex 5 for credit risk segmentation overview).
Some national discretions are time-limited by design and seek to reduce any negative externalities Banks apply their own interpretations of relevant national rules, to determine how their internal
arising from the implementation of Basel III, particularly as it relates to the more penal deduction asset-class or business-line definitions map to the Basel-defined traded and non-traded boundary,
items. Other national variances are more permanent and so represent more significant and and asset class definitions. In many cases, the appropriate classification is evident. For some assets,
persisting differences (refer to the Basel Committee’s regulatory consistency reviews of national however, there may be ambiguity or flexibility, which could lead to unintended (or intended)
implementation standards). For example, EU regulators permit IRB banks to permanently apply the regulatory arbitrage. Examples of potential ambiguity or discretion include: assignment of positions
SA for certain portfolios, including material sovereign credit risk portfolios, and permit the exclusion between the trading book and banking book; lending to small businesses under either the corporate
of certain portfolios from the CVA risk charges, which can lead to lower overall RWAs. SME or the “other” retail category; heterogeneous practices for determining asset default and its
subsequent re-performance; and definition of a securitisation (credit tranching).
Accounting Practices
As financial reporting information forms the basis for the calculation of regulatory capital, varying
accounting practices can generate differences in Basel III ratios across banks, despite growing
international convergence in accounting standards. International Financial Reporting Standards
(IFRS) are widely used around the world (except for the US). Yet the financial reporting equity
number can still vary considerably from bank to bank even under the same accounting regime, due
to the flexibility a company has in how to account for certain assets, such as bonds or loans. And
banks in some jurisdictions still use local GAAP equity, which can differ substantially from IFRS
equity, as the starting point to determine regulatory capital.
Assets reported as held for trading may, but do not always, correspond to assets in the trading book
under Basel III. If a loan is reported as held for trading or available for sale, then changes in market
value (or perceived market value) of positions will impact equity, whereas assets carried at

Banks - Regulation
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2. The securitisation external ratings-based approach (SEC-ERBA) assigns risk weights

Primer: Securitisation Reforms according to the credit rating and seniority of the underlying exposure. Similar to the SEC-
The current securitisation risk-weighting regime inherited from Basel II consists of two main IRBA, it incorporates additional risk drivers for tranche thickness and tranche maturity.
hierarchies, which include several options and variations that are applied depending on whether the
originator or an investor is calculating tranche-level risk-weightings: 3. If the securitisation tranche is unrated, or the national authority forbids the use of credit
ratings (e.g. the US) then the securitisation standardised approach (SEC-SA) is applied. This
1. SA for banks that apply the SA credit risk for the underlying pool of securitised exposures. uses a supervisory formula, with the following inputs: the weighted-average SA capital
Risk-weights depend on the credit rating of the tranche, subject to a 20% risk-weight floor; charge had the underlying exposures not been securitised (KSA); the ratio of delinquent
or underlying exposures to total underlying exposures in the securitisation pool; and credit
enhancement levels to the tranche being assessed.
2. IRB approach for banks that have a supervisory-approved IRB model for the type of
underlying exposures securitised, subject to a 7% risk-weight floor. The IRB securitisation If none of the above can be used by a bank, the exposure would have a risk weight of 1,250%.
approach further bifurcates into the following methods:
A more recent update to the revised framework establishes preferential capital treatment for
a. A credit ratings-driven approach if the tranche is rated, albeit using a more granular “simple, transparent, and comparable” (STC) securitisations, which shall benefit from a 10% risk-
look-up table than under the SA; or weight floor, versus 15% under the other revised approaches. The STC criteria aim to foster
simplicity in the underlying assets and structures of securitisations, to aid risk assessment and
b. An IRB supervisory-formula approach (SFA), which uses the capital charge for the
transparency.
underlying exposures using the IRB framework (KIRB) as the key input, if the
securitisation tranche lacks a credit rating. For re-securitisation exposures, in contrast to the current framework, which allows either the SA or
IRB methods to be used, subject to a 20% risk-weight floor under IRB, the revised securitisation
If the above methods cannot be used, the exposure is risk-weighted at 1,250%.
framework will only permit the SEC-SA to be used, subject to a 100% floor.
Certain weaknesses were perceived in the Basel II securitisation framework during the financial
crisis, such as: Key Implications for Securitisation
The revised framework simplifies the range of approaches compared with Basel II, and reduces the
A mechanistic reliance on credit ratings;
mechanistic reliance on credit ratings. IRB capital requirements increase due to the use of a higher
Excessively low risk-weights for highly rated securitisation exposures; risk-weight floor, though conversely banks using the SA will benefit from lower risk-weight floors.
Excessively high risk-weights for low-rated senior securitisation exposures;

Cliff effects; and
Insufficient risk sensitivity of framework.
In December 2014, the BCBS published its revised securitisation framework. The revised
framework aims to address certain shortcomings in the Basel II securitisation framework and to
strengthen capital standards for securitisation exposures held in the banking book, and came into
effect in January 2018. The revised framework increases the risk-weight floor under all approaches
to 15%, meaning the highest-quality securitisations are subject to higher capital charges.
The current regime revises the current Basel II-based hierarchies to reduce reliance on credit
ratings, simplify the hierarchy and limit the number of approaches:
1. The securitisation internal ratings-based approach (SEC-IRBA) is a modified version of the
Basel II IRB SFA, incorporating tranche maturity as an additional risk driver alongside KIRB
for the underlying securitised exposures.

Banks - Regulation
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The criteria used in Pillar 2 SREP assessments vary between jurisdictions. Supervisors are expected
Primer: Pillar 2/Supervisory Review Process Regime to publicly disclose their approach, along with factors considered when setting target or trigger
The purpose of the Pillar 2 supervisory review process is to ensure that banks carry out an overall ratios (for supervisory intervention) above regulatory minima. For the supervision of cross-border
assessment of risks in their business and that they carry adequate capital. Drawing upon banking groups, Pillar 2 requires enhanced and practical co-operation among supervisors.
supervisory guidance (updated in 2009) and the Committee’s Core Principles for Effective Banking
Supervision, Pillar 2 is based on four key principles: Pillar 2 Capital in Excess of Pillar 1 Minima: Supervisors expects banks to operate above Pillar 1
minimum capital ratios and hold capital in excess of the minimum:
1. Banks carry out an internal capital adequacy assessment process (ICAAP);
• As a buffer against fluctuations in the overall capital ratio occurring in the normal course of
2. Supervisors carry out their supervisory review and evaluation process (SREP); business;
3. Pillar 2 requires banks to hold capital above Pillar 1 regulatory minima; and • Because the scope of Pillar 2 risk assessment is broader than under Pillar 1; and
4. Supervisory intervention to prevent bank capital from falling below minimum requirements. • Banks’ SREPs often reveal inadequacies in risk and capital management processes, systems,
and oversight, that usually result in capital surcharges.
The ICAAP: This is a systematic and disciplined process undertaken by the bank (including a review
of its policies and procedures), designed to ensure that the bank identifies, measures, monitors and Supervisory Intervention: Interventions at an early stage, to prevent a bank’s capital from falling
controls all material risks, including those not captured under Pillar 1. The ICAAP is then used to set below minimum levels required to support its risk characteristics, are generally determined by
the amount and quality of internal capital required to be retained by the bank (floored by the Pillar national legislation, but may include (and not limited to):
1 minimum requirement), in relation to its risk profile, control environment, strategy and business
plan. The entire ICAAP should be subject to a robust governance process that the board and senior Increasing monitoring of the bank;
management are ultimately responsible for. At minimum, the ICAAP should consider the following: Requiring the bank to improve and resubmit its ICAAP;
Regulatory capital and liquidity ratios and requirements; Requiring the bank to submit a capital restoration plan;
Peer comparisons; Placing restrictions on bank activities, acquisitions, distributions;
Expectations of counterparties and rating agencies; Requiring the replacement of senior management and/or the board of directors; and
Concentrations of credit and other risks; Ultimately, closure of the bank.
Business cycle effects;
Programme of forward-looking stress tests to uncover and highlight vulnerabilities;
Modelling and risk analysis (including the use of internal models not used for Pillar 1); and
Other qualitative and subjective factors.
The SREP: This is a supervisory review of a bank’s ICAAP, which focuses on identifying, reviewing
and evaluating all risk and control factors. The SREP typically takes place via a mixture of on-site
examinations, off-site surveillance, meetings with bank management, periodic reporting and
reviewing of the work of internal and external auditors. Through a process of dialogue and
challenge, regulators assess, review and evaluate whether the target level of capital chosen is
comprehensive and relevant to the current operating environment and appropriate to the nature
and scale of the bank’s business. Compliance with minimum standards and requirements is
evaluated, including whether senior management is exercising appropriate levels of governance and
oversight.

Banks - Regulation
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Banks are also required to hold capital explicitly against credit spread risks in the banking book
Primer: Interest-Rate Risk in the Banking Book (IRRBB) (CSRBB), e.g. for fair-valued securities held as part of a liquidity buffer. This is a risk that is closely
IRRBB specifically refers to the current or prospective risk to the bank’s capital and earnings arising associated with IRRBB, arising from variations in the premium that the market requires for different
from adverse movements in interest rates that affect its banking book (i.e. non-traded) positions. types of instruments (reflecting both credit and other market risks, such as liquidity). In the past,
When interest rates change, the present value and timing of future cash flows change. This can banks would sometimes ignore CSRBB or reassign these risks into their trading book - where it
affect a bank’s earnings by altering its interest-sensitive income and expenses, thus affecting its net could be offset by, and netted out against, other trading positions. Or, to reallocate positions to the
interest income (NII). It can also affect the underlying value of a bank’s assets, liabilities and off- banking book. This could mean they were holding reduced or no capital charges to cover CSRBB.
balance sheet instruments – and hence its economic value (EV), or economic value of equity (EVE). The new requirement will further limit incentives for arbitrage between banking and trading book
assignment.
EVE shows the economic changes to equity, whereas an NII assessment reflects changes to future
profitability. In terms of time horizon, EVE considers the remaining life of the balance sheet in a Under the current standard regulators use tougher thresholds to ascertain if a bank is an outlier in
static view (a run-off view). In contrast, an NII assessment focuses on the short to medium term and terms of its capitalisation of IRRBB, and can impose a more conservative “standardised” capital
generally assumes the rollover of maturing positions, potentially applying a dynamic view of future calculation which is likely to lead to higher requirements than using internal models.
business opportunities. While banks tend to use NII more frequently for managing IRRBB,
supervisors appear to prefer EVE for its inference to capital adequacy. Key Implications of the Revised IRRBB Framework
The revised IRRBB regime promotes greater standardisation of behavioural and modelling
As the assessment of IRRBB forms part of Pillar 2, banks can take risky exposure to interest rate
assumptions, introducing a more level playing field across banks. An overhaul of the stress tests is
changes in the banking book and will not be subject to Pillar 1 minimum capital requirements (in
long overdue and will allow greater insight into the possible impact of a variety of interest-rate
contrast to a similar position in the regulatory trading book). Under Pillar 2, banks are required to
scenarios. Enhanced disclosure requirements provide greater transparency, allowing market
make an assessment of their IRRBB capital requirements using internal models and processes,
participants to form a clearer picture of how interest-rate risk affects capital and earnings.
based on the BCBS’s “Principles for the management and supervision of interest rate risk” (2004
IRR Principles – recently updated, see right).
Policy Changes
Recent policy updates seek to minimise opportunities for regulatory capital arbitrage, while
improving the consistency of banks’ approaches under Pillar 2, and make it easier for investors to
compare data across banks and banking systems.
From January 2023, the revised market risk framework will significantly restrict banks’ ability to
reassign instruments/positions between trading and banking books by defining a more objective-
based boundary (in contrast to previous much looser standards). Banks will also be subject to more
severe limitations on the use of so-called “internal risk transfers” (IRT) trades, which transfer
interest-rate risk from the trading book to the banking book, or vice versa, in order to optimise
capital requirements in either the Pillar 1 minimum requirements regime or the Pillar 2 regime.
The current IRRBB standards (finalised April 2016, implemented before 2018) significantly revise
the BCBS’s 2004 IRR Principles, while maintaining the ability of banks to calculate IRRBB capital
requirements under Pillar 2. These guidelines are intended to promote a greater standardisation of
behavioural and modelling assumptions, and include enhanced disclosure requirements (see Fitch
Wire). In the place of a simple 200bp yield curve shift, banks have to apply six new common shock
and stress scenarios to determine their stressed capital requirements under NII or EVE measures.
Outcomes of the common scenarios have to be disclosed using new fixed-form quantitative
disclosure templates, promoting greater consistency, transparency and comparability in the
measurement and management of IRRBB.

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risk assessment. These new templates require banks to disclose concurrently with financial
Primer: Pillar 3 Disclosures/Market Discipline Regime reporting accounts. Many disclosures are required quarterly, with the majority of disclosure
Pillar 3 sets out disclosure requirements that aim to provide sufficient transparency for required semi-annually.
stakeholders – including investors and rating agencies – so as to ensure that the price that banks
pay to raise capital in the market reflects the level of risk undertaken by the issuer. These disclosure In terms of the medium of disclosure, banks are no longer able to spread the regulatory disclosures
requirements were first issued in 2004 as part of the original Basel II framework, with additional across a variety of sections or locations. Instead, disclosures must be presented within a standalone
requirements pertaining to market risk (Basel 2.5 changes) and securitisation, concentration risk, document or within a discrete section or appended as a document to their financial reports. The
and valuation risk enhancements post-crisis. regulatory disclosures also have to be archived on a website by the bank or the national regulator.
The regulatory disclosures are intended to complement bank financial reporting disclosures Further enhancements were finalised in March 2017 that consolidate all existing BCBS disclosure
mandated by accounting standards, but are not required to be released as part of published financial requirements into the Pillar 3 framework. In addition, a “dashboard” of key prudential metrics was
accounts. In practice, therefore, Pillar 3 disclosures may be dispersed across published financial introduced, and a new disclosure requirement for disclosure of prudent valuation adjustments.
reporting and/or within discrete Pillar 3 disclosure documents. In general, banks are required to Updates to reflect the TLAC regime for G-SIBs and the revised market risk framework were also
make annual disclosures, with larger banks required to disclose high-level capital adequacy added. These standards took effect along the same timelines as the final implementation of the
information (e.g. key ratios) on a quarterly basis. regimes (i.e. from 2017).
Currently, banks are required to make qualitative and quantitative Pillar 3 disclosures under several 2018 Disclosure Update – Takes Effect From 1 January 2023
headings, including: In February 2017, the Basel Committee consulted upon proposed enhancements, mainly relating to
the December 2017 finalisation of the Basel III RWA revisions. These include: new or revised
Scope of regulation;
requirements for credit/operational risks, the leverage ratio and credit valuation adjustment (CVA);
Capital structure (updated 2010 with Basel III); a new disclosure that would benchmark a bank’s RWAs as calculated by its internal models with
RWAs calculated according to the SAs; and new disclosure requirements on asset encumbrance and
Capital adequacy;
capital distribution constraints. The revised disclosure package was issued as a standard in
Credit risk; December 2018, and will mainly take effect from 1 January 2023.
Equities in the non-trading book; Primer: Basel III Capital Buffers
Credit risk mitigation; Banking groups are subject to at least two CET1 capital-based buffers to manage prudential and
Securitisation (updated in 2009); macroprudential risks – the capital conservation buffer and the countercyclical buffer. These
buffers sit above minimum requirements and apply at the group consolidation level. They share
Market risk (updated in 2009); similar design features and have two objectives: to ensure that banks absorb losses in times of stress
Operational risk; without breaching their minimum requirements; and second, to help maintain the flow of credit to
the real economy in a downturn by lending to creditworthy businesses and households. A breach of
Interest rate risk in the non-trading book; and the capital buffers generally results in restrictions on CET1 distributions. Items considered to be
distributions include discretionary payments on AT1 instruments, dividends and share buybacks
Remunerative practices and policies (introduced 2011).
and discretionary bonus payments to staff. However, payments that do not result in a depletion of
2015 Disclosure Update CET1, e.g. certain scrip dividends, are not considered distributions.
Basel III requires banks to disclose additional information in respect of capital structure including Capital Conservation Buffer (CCB, 2.5% RWA): The CCB is a prudent buffer that sits on top of
adherence to capital buffers, the regulatory leverage ratio and liquidity requirements (for the LCR banks’ Pillar 1 minimum capital requirements (and potentially on top of Pillar 2-based CET1
and the NSFR). requirements, depending on supervisory implementation) and is designed to ensure banks build up
buffers outside periods of stress, which can be drawn down when losses are incurred.
In contrast to the non-prescriptive and flexible design of the initial Basel II and post-crisis disclosure
templates, January 2015 saw the finalisation of a comprehensive update requiring quantitative Countercyclical Buffer (CcyB, 0%-2.5% RWA): An extension of the capital conservation buffer, the
disclosures using fixed-form tables and requiring significantly more detail for risk exposures and CcyB is used to bolster banks’ loss absorbency during periods of rapid price appreciation or credit

Banks - Regulation
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growth not supported by fundamentals, which can be run down or used to absorb losses that may Maximum Payout Ratio
crystallise during recessionary periods. The buffer rate is set for all banks in a given jurisdiction at (% of eligible retained earnings, assuming 0% CcyB)
the local regulator’s discretion (12 months’ notice of rate-setting is usually provided). The CcyB is
calculated as the weighted average of the buffers in effect in the jurisdictions to which banks have a Retained income 2016 2017 2018 2019
credit exposure to private-sector counterparties (so excludes public/sovereign counterparties). As > 2.5% No limitation
a non-zero CcyB set for domestic credit exposures in one jurisdiction will require banks in other 1.875% < buffer ≤ 2.5% No limitation 60
jurisdictions with credit exposures to that country to calculate and then hold CET1 for a 1.406% < buffer ≤ 1.875% 60 40
proportionate CcyB.
1.25% < buffer ≤ 1.406% No limitation 40
Maximum Payout Ratio Complexities 0.938% < buffer ≤ 1.25% 60 20
Banks are restricted from making discretionary distributions to AT1 and equity investors if they 0.625% < buffer ≤ 0.938% No limitation 40 20
hold insufficient CET1 to meet minimum applicable capital buffer requirements (see tables to the 0.469% < buffer ≤ 0.625% 60 20 0
right). Regulators in some jurisdictions (e.g. the EU) also impose distribution restrictions if Pillar 2 0.313% < buffer ≤ 0.469% 40 0
requirements are also pierced. The maximum payout can only be made if there are sufficient
0.156% < buffer ≤ 0.313% 20 0
available distributable items (ADI), i.e. profits and reserves available for distribution under national
company legislation and bank statutes. ADI disclosure is often poor. < 0.156% 0
Capital Buffers: Phase-in Schedule
Capital buffer phase-in schedules aligned
(%) 2014 2015 2016 2017 2018 2019 Key Implications of the Capital Buffers
Maximum potential CcyB - - 0.63 1.25 1.88 2.50 The requirement to hold higher common equity against macroprudential risks will result in a lower
Min CET1 + CCB + max CcyB 4.00 4.50 5.75 7.00 8.25 9.50 return on equity unless banks pass on the additional cost of capital to their customers.
Min CET1 + CCB + max CcyB 5.50 6.00 7.25 8.50 9.75 11.00 More recently, the Basel Committee has commenced an evaluation to assess material unintended
Min total capital + CCB + max CcyB 8.00 8.00 9.25 10.50 11.75 13.00 effects from the role and setting of capital buffers, including lessons learnt from the Covid-19
pandemic in 2020-2021. An evaluation report, due 2022, may recommend changes to the regime
that potentially make it easier for banks’ to pierce capital buffers during crisis without leading to
certain types of distribution restrictions e.g. when paying AT1 coupons.

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better recognise netting and margining practices for derivatives and repo-style transactions that
Primer: Basel III Leverage Ratio may benefit banks with capital market activities.
The LR was introduced into the Basel framework to help contain the build-up of excessive leverage
in the financial system and to serve as a risk-insensitive backstop to address model risk for credit Regular-Way Purchases/Sales: There will be a harmonisation of the accounting for regular-way
exposures. The ratio comprises a Tier 1 capital numerator taking into account transitional purchases or sales of unsettled trades, which currently differs across and within accounting
arrangements, divided by an LR exposure denominator. frameworks depending on trade date versus settlement date accounting. Alignment could lead to a
reduction in SFT exposure assets for certain banks in certain jurisdictions.
Leverage = Off-Balance-Sheet Items: The weighting factors used to convert off-balance-sheet nominals to on-
Tier 1 Capital
= ≥ 3%+ balance-sheet equivalents will be aligned with the revised SA credit risk standard. This increases the
Ratio (LR) On/Off-BS assets + Deriv + Sold CDS LRE for undrawn credit commitments (including unconditionally cancellable facilities for
+ Systemically-important banks may be subject to additional buffers/numerator criteria corporates), in line with the revised SA.
True-Sale Securitisations: An originating bank may exclude securitised exposures from its LRE if
The LR must be calculated at the end of each quarter, with supervisory discretion to require more the securitisation meets the operational requirements for the recognition of risk transference.
frequent calculations, such as daily or monthly averaging. Public disclosure of banks’ LRs Banks meeting these conditions must include any retained securitisation exposures in their LRE.
commenced in 2015 and has applied as a legally binding Pillar 1 requirement since 1 January 2018. This would reduce LR exposure for banks engaged in securitisation.
The Leverage Ratio Exposure (LRE) Measure Comprises: Key Implications of the Leverage Ratio
• On-balance-sheet assets, excluding securities financing transactions (SFTs, i.e. repo-style As a non-risk-weighted measure, the LR especially affects banks whose business model involves
transactions and margin loans) and derivatives; low-margin and low-risk, but high-volume, lending (e.g. certain types of mortgage lending and
municipal finance). To mitigate this, banks may alter their asset structure towards riskier assets to
• SFT exposures, with limited recognition of netting of cash receivables and cash payables with
generate higher margins. However, revisions to the exposure-based elements of the LR will offer
the same counterparty under strict criteria;
some relief to banks operating as clearing members of CCPs, or engaging in true-sale securitisation
• Derivatives exposures at replacement cost (net of cash variation margin meeting a set of strict activities.
eligibility criteria) plus an add-on for potential exposure based on the current exposure method
(CEM);
• Written credit derivative exposures at their effective notional amount (net of negative changes
in fair value that have been incorporated into the calculation of Tier 1 capital) reduced by the
effective notional amount of purchased credit derivatives that meet offsetting criteria related
to reference name, level of seniority and maturity; and
• Off-balance-sheet exposures, obtained by multiplying notional amounts by the credit
conversion factors in the standardised approach to credit risk, subject to a floor of 10%.
Subsequent revisions to the leverage ratio regime that come into force from 2023 include:
G-SIB LR Buffer: The LR buffer will be set at 50% of a G-SIB’s higher-loss absorbency risk-weighted
requirements, met with Tier 1 capital. For example, a G-SIB subject to a 2% higher-loss absorbency
requirement would be subject to a 1% LR buffer requirement. Capital distribution constraints will
be imposed on a G-SIB that does not meet its LR buffer requirement.
Derivative Exposures: The CEM is replaced by a modified version of the standardised-approach to
counterparty credit risk (SA-CCR, as finalised in 2014); centrally cleared client derivative
transactions will receive preferential treatment (recognition of collateral posted). These changes

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positions. Offsetting between long and short positions in different issues is permitted, based on
Primer: Large Exposure Limits Regime prescriptive rules and criteria;
The purpose of LE limits is to constrain the maximum loss a bank could face in the event of a sudden
failure of a single counterparty or a group of connected counterparties. Current LE guidelines • Look-Through Approach (LTA) for exposures to structured transactions (eg funds,
(issued in 1991) limit credit exposures to a counterparty or a group of connected counterparties to securitisations, index positions), based on a pro-rata share of the structure multiplied by the
25% of Tier 1 and Tier 2 capital (including off-balance-sheet and contingent items). Banks are value of the underlying asset in the structure. Exemption from LTA if the underlying
required to identify and report to their national authorities single-name credit concentrations equal counterparty exposure is smaller than 0.25% of the bank’s Tier 1 capital. Where the LTA cannot
to 10% Tier 1 plus Tier 2. be performed, the bank must aggregate all its unknown exposures as if they were to a single
“unknown” client, to which the large exposure limit would then apply;
The guidelines allow a relaxation or total exemption of sovereign and public-sector entities from the
LE limits, and similarly foresee a relaxation of limits for short-tenor interbank exposures. In addition, • Preferential treatment of certain covered bonds, potentially as low as 20% of nominal value, if
banks are required to apply stricter constraints upon exposures with related parties, below the criteria are met; and
standard 25% threshold. • Exposures to sovereigns are fully excluded from LE, as are intraday interbank exposures. The
BCBS will review whether any interbank limits should apply and consider the preferential
Basel III LE Update – Go-Live Date January 2019 treatment of cleared derivatives.
Due to the high-level nature of the 1991 guidelines, material global differences emerged in national
jurisdiction implementation of LE regimes, spanning its scope of application, actual limits, the Key Implications of the Updated LE Regime
definition of capital, methods for calculating exposure values, use of credit risk mitigation By defining a more restrictive numerator based on Tier 1 capital, and broader criteria to define the
techniques, and counterparty exemptions. extent of connectiveness, banks are likely to identify and report higher single-name concentrations
In response, the BCBS issued a comprehensive framework update in 2014, to be implemented by under the regime. The largest banking groups are expected to diversify their exposures among more
January 2019. Key features of the new regime include: G-SIBs, or away from other G-SIBs. Requirements to look through to the underlying assets and
exposures of structured products will lead to a more granular risk concentration assessment. These
A stricter definition of capital, based on Tier 1 rather than Tier 1 plus Tier 2 capital; changes will require significant improvements in data collation, and systems/processes, to avoid
breaching connected or “unknown” counterparty limits.
• No change to the 25% LE limit, but to mitigate the risk of contagion between G-SIBs, a relatively
tighter limit of 15% of Tier 1 capital applies to exposures between G-SIBs;
• Greater clarity on defining connected counterparties, based on control and economic
interdependence (with banks required to conduct in-depth analysis where the sum of
exposures to a single counterparty exceeds 5% of Tier 1 capital);
• Clearer exposure definitions and quantification. Non-derivative exposure amounts comprise
the accounting carrying value, with off-balance-sheet commitments weighted using credit
conversion factors (CCFs) per the SA credit risk (10% CCF floor);
• Derivative counterparty exposures calculated under the forthcoming standardised approach
to counterparty credit risk (SA-CCR);
• SFT exposures calculated using the methodology within the forthcoming revised SA credit risk
regime (to be finalised as part of the “Basel IV” RWA reforms);
• Credit risk mitigation permitted under the RWA regime may reduce the value of credit
exposures;
• Explicit inclusion of trading book positions that reference credit or issuer risk (ie interest rate,
FX and commodities risk positions are excluded), generally based on the market value of

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Primer: Liquidity Coverage Ratio Overview: LCR Components

The LCR measures a bank’s short-term resilience to a liquidity stress scenario. The final standard High Quality Liquid Assets/haircuts Net Cash Outflows/Run-Off Rates
requires that all net cash outflows caused by a deposit and funding run-off be covered by high- Level 1 HQLA:@ 0% haircut Cash outflows (not exhaustive/key items)
quality liquid assets (HQLA) during a time period of at least 30 calendar days. The LCR ratio applies • Cash • Retail deposits, stable/less stable, 5%/10% outflows
• Central bank reserves • Unsecured wholesale funding:
fully from January 2019. LCR disclosures (quarterly or semi-annual) commenced 1 January 2015. • Marketable securities from sovereigns, central • Stable/Less stable SME (5%/10% outflows)
Banks have to maintain a ratio in excess of 100%, but during a period of actual financial stress, banks banks, non-central government PSEs, BIS, IMF, EC, • Corporates, sovereigns, PSEs (40% outflow)
may use their stock of HQLA, thereby falling below 100%. multilateral development banks with risk weight of • Other (e.g. financials) (100% outflow)
0% under credit risk SA: • Secured Funding backed by:
• Debt w/non-zero risk weight of • Level 1/2 assets (0%/15% outflow)
Liquidity • sovereigns, sovereign/central banks with non- • Other assets w/ domestic central banks,
High Quality Liquid Assets (HQLA) zero risk weight in domestic currency in sovereigns, PSEs (25% outflow)
Coverage Ratio = ≥ 100% country where liquidity risk is taken/ bank‘s • Other (e.g. financials) (100% outflow)
Net Cash Outflows: 30 Days home country • Other liabilities from
(LCR)
• Sovereigns, domestic sovereign/central banks • Net derivative payables (100% outflow)
in foreign currency if debt matches currency • Maturing ABCP, SIV, SPV, ABS (100% outflow)
needs of the bank in that jurisdiction • Other contractual outflows (100% outflow)
The stress scenario combines a market-wide and idiosyncratic stress. It assumes a run-off of a • Committed credit/liquidity lines
proportion of retail deposits, a partial loss of other funding capacity, and unscheduled drawdowns • Retail/SME (5% outflow)
Level 2A HQLA: @15% haircut • Corporates, sovereigns, central banks, PSEs –
on committed but unsecured facilities provided to clients (see right). It also requires a bank to credit/ liquidity (10%/30% outflows)
• Marketable securities from sovereigns, central
consider contractual outflows from a three-notch credit rating downgrade. banks, non-central government PSEs and • Others (100% outflow)
multilateral development banks with risk weight of • Contingent funding
HQLA Eligibility 20% under credit risk SA • Credit, liquidity facilities, Guarantees, Letters of
• Non-FI Corporate bonds/ covered bonds rated at credit (outflows set at national discretion)
HQLA assets should be liquid in markets during a time of stress and, in most cases, be eligible for use least AA-
in central bank operations. HQLA comprises Level 1 and Level 2 assets. Level 1 assets are the -
Cash inflows
highest-quality, most liquid marketable securities (e.g. sovereign debt that benefits from 0% SA risk- • Receivables from Non-fin/Fin.(50%/100% inflow)
weights), and there is no limit on the extent to which a bank can hold these assets to meet the LCR. Level 2B HQLA: @25% - 50% haircut • Operational deposits from Fin (0% inflow)
Level 2 assets are capped at 40% of HQLA. Supervisors may define within Level 2 and additional • Residential mortgage ABS rated at least AA • Net derivatives receivables (100% inflow)
meeting certain quality criteria (25% haircut) • Secured funding backed by
level of assets – Level 2B – which in turn may not exceed 15% of total HQLA. Examples of Level 2A • Corporate bonds and CPs from non-financial • Level 1/2 assets (0%/15% inflow)
assets include corporate bonds and covered bonds meeting certain eligibility criteria, including issuers, rated at least BBB-, and listed equities • Other assets (100% inflow)
being rated at least ‘AA-’. (50% haircut) meeting quality criteria • Credit/liquidity facilities (0% inflow)

Net Cash Outflows
Total net cash outflows are defined as total expected cash outflows, minus total expected cash
inflows, for 30 calendar days (funding surpassing the 30-day horizon is not included). Total expected Key Implications of the LCR
cash outflows are calculated by multiplying the outstanding balances of various categories or types The LCR incentivises banks to gather more deposits and to reduce short-term wholesale funding
of liabilities and off-balance-sheet commitments by the rates at which they are expected to run off reliance. It also increases the desirability of HQLA securities, which could lead to the leverage ratio
or be drawn down (see below). Total expected cash inflows are calculated by multiplying the (rather than the capital ratio) becoming a binding constraint. Limited supply of HQLA in local
outstanding balances of various categories of contractual receivables by the rates at which they are currency in some jurisdictions (ie those with low indebted sovereigns) could result in additional FX
expected to flow in, subject to an aggregate cap at 75% of total outflows. Consequently, 25% of cash risk or the need to hedge this.
outflows have to be covered by liquid assets.

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Primer: Liquidity Net Stable Funding Ratio Net Stable Funding Ratio - Categories and Factors
The NSFR is a longer-term structural ratio to address liquidity mismatches and to provide incentives
Available Stable Funding Categories Required Stable Funding Categories
for banks to use stable liquidity sources to fund their activities. The NSFR is calculated by dividing a
bank’s available stable funding (ASF) by its required stable funding (RSF). The ratio must always be • Regulatory capital, • Cash,
• Other capital instruments and liabilities with effective • Central bank reserves, central bank assets <6 months
greater than 100%. Based on the final standard, large internationally active banks have been maturity => 1 year (100% factor) residual maturity (0% factor)
required to comply since 1 January 2018, and to provide NSFR disclosures from the date of the first
reporting period after 1 January 2018. • Stable retail/SME deposits (as in LCR) with effective
• Unencumbered level 1 LCR assets excluding cash,
• Central bank reserves (5% factor)
maturity < 1 year or without maturity (95% factor)
Net Stable • Loans to FI with effective maturity < 6 months secured with
(1yr) Available Stable Funding • Less stable retail/SME deposits (as in LCR) with residual level 1 LCR assets (10% factor)
Funding Ratio = ≥ 100% maturity < 1 year (90% factor)
(1yr) Required Stable Funding • All other unencumbered loans to FI with <6 month residual
(NSFR) maturity,
• Secured/unsecured funding with effective maturity < 1 • Unencumbered level 2A LCR assets (15% factor)
year from non-financial corporates, sovereigns, PSEs,
The ASF and RSF requirements specified in the NSFR (see right) are adjusted to reflect the degree supranational banks, • Unencumbered level 2B LCR assets,
of stability of liabilities and liquidity of assets. The NSFR also factors in asset quality and liquidity • Operational deposits (as in LCR), • Loans to banks with effective maturity =>6 months and < 1
• Other secured/unsecured funding with effective year,
value, recognising that some assets do not require full financing by stable funding where they can maturity => 6 months < 1 year including central banks • Operational deposits held at other FI,
be securitised or are tradable to secure additional funding. Off-balance-sheet commitments and and FI (50% factor) • All other assets with effective maturity < 1 year not
contingencies that create potential calls on liquidity require additional stable funding sources. mentioned above (50% factor)
• All other liabilities and equity not included above,
Available Stable Funding including liabilities without stated maturity, • Unencumbered residential mortgages (with SA risk weight
• Derivative liabilities net of derivative assets (if liabilities <=35%) of effective maturity > 1 year,
ASF equals the weighted sum of a bank’s capital and liability positions. A scalar factor is applied to greater than assets) (0% factor) • Other loans (except to FI) with SA risk weight <= 35% and
capital and liabilities, based on their accounting carrying values, before application of regulatory effective maturity > 1 year (65% factor)
deductions, filters or other adjustments (see right). The weightings differ based on the instrument
• Other performing loans with SA risk weight > 35 % and
and its effective maturity (residual maturity, unless it contains rights that allow for early effective maturity > 1 year,
termination, in which case it is the earliest when investors or the bank can exercise their termination • Non-defaulted securities ineligible as LCR HQLA, Physically
rights). Retail deposits of less than one year are behaviourally more stable than wholesale funding traded commodities (incl. gold) (85% factor)
of the same maturity.
• Net derivative receivables,
• Other assets not included above (100% factor)
Required Stable Funding
RSF equals the weighted sum of a bank’s assets and off-balance-sheet items. As for ASF, a scalar
factor is applied to the carrying value of all assets and exposures (with weighted category values
summed for total RSF). The factors represent the portion of a particular asset that must be Key Implications of the NSFR
underpinned with stable funding because it cannot easily be converted into cash. The NSFR will push banks towards increasing retail customer deposits, long-term wholesale funding
(greater than six-month interbank lending) and equity. Short-term funding and asset encumbrance
is discouraged under the NSFR. This may point to higher funding costs, as there are both competition
and expected higher returns for this liability structure. Business models based around retail
deposits will find it easier to satisfy the NSFR. Banks dependent on short-term wholesale funding
may find it challenging to meet the NSFR. However, G-SIBs that issue TLAC debt are likely to satisfy
the NSFR owing to the large amount of stable funding to be issued.

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Annex 1: Basel III-Related External Bibliography

Final standards – documents Date issued Topic Current standard
Minimum capital requirements for market risk 14 January 2019 Pillar 1 – Market risk RWA No: Go-live from 2023
Pillar 3 disclosure requirements - updated framework 11 December 2018 Pillar 3 – Disclosure requirements No: end-2020/January 2023
Pillar 3 disclosure requirements – regulatory treatment 30 August 2018 Pillar 3 – Disclosure requirements Yes
of accounting provisions
G-SIBs: Revised assessment methodology and the 5 July 2018 Pillar 1 – Capital Buffers No: Go-live from 2021
higher loss absorbency requirement
Treatment of extraordinary monetary policy operations 29 June 2018 Pillar 1 – Liquidity risk Yes
in the Net Stable Funding Ratio
Capital treatment for simple, transparent and 14 May 2018 Pillar 1 – Securitisation credit risk Yes
comparable short-term securitisations
Basel III: Finalising post-crisis reforms (“Basel III 7 December 2017 Pillar 1 – RWA revisions No: Go-live from January 2023
“Endgame” Revisions)
TLAC holdings – Final standard (treatment of banks’ 12 October 2016 Pillar 1 – Definition of capital No: Go-live January 2019
holdings of TLAC instruments)
Revisions to securitisation framework – Simple, 11 July 2016 Pillar 1 – Securitisation credit risk Yes
Transparent, Comparable (STC)
Statement on capital arbitrage transactions 2 June 2016 Pillar 1- Definition of capital Yes
Interest rate risk in the banking book 21 April 2016 Pillar 2 – Interest rate risk Yes: Disclosure go-live January 2018
Minimum capital requirements for market risk 14 January 2016 Pillar 1 – Market risk RWA No: Go-live January 2023 (previously January 2019)
Total Loss-Absorbing Capacity (TLAC) principles and 9 November 2015 Crisis management/Pillar 1 No: Go-live January 2019
term sheet
Revised Pillar 3 disclosure requirements 28 January 2015 Pillar 3 – Disclosure requirements Yes
Revisions to the securitisation framework 11 December 2014 (updated 11 July 2016) Pillar 1 – Securitisation credit risk RWAs Yes
G-SIB assessment methodology – score calculation 6 November 2014 Pillar 1 – G-SIB capital buffer Yes
Basel III: The net stable funding ratio 31 October 2014 Pillar 1 – Liquidity risk Yes: Disclosure go-live after January 2018
Supervisory framework for measuring and controlling 15 April 2014 Pillar 1– Concentration risk No: Go-live January 2019
large exposures – final standard
Capital requirements for bank exposures to central 10 April 2014 Pillar 1 – Credit risk Yes
counterparties – final standard
The standardised approach for measuring counterparty 31 March 2014 Pillar 1 – Credit risk Yes
credit risk exposures (SA-CCR)
Basel III leverage ratio framework and disclosure 12 January 2014 Pillar 1 – RWA constraints Yes: Disclosure go-live January 2015
requirements

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Annex 1: Basel III-Related External Bibliography (Cont)

Final standards – documents Date issued Topic Current standard
Capital requirements for banks’ equity investments in 13 December 2013 Pillar 1 – Credit risk Yes
funds – final standard
Basel III: The Liquidity Coverage Ratio and liquidity risk 7 January 2013 Pillar 1 – Liquidity risk Yes: Phase-in from January 2015
monitoring tools
A framework for dealing with domestic systemically- 11 October 2012 Crisis management Yes
important banks – final document
Principles for the supervision of financial 24 September 2012 Bank supervision Yes
conglomerates – final report
Core principles for effective banking supervision 12 September 2012 Bank supervision/Pillar 2 Yes
Globally-systemically important banks: Assessment 4 November 2011 (updated July 2013) Crisis management/Pillar 1 Yes
methodology and the additional loss absorbency
requirement – final document
Basel III: A global regulatory framework for more 16 December 2010 (updated June 2011) Key Basel III rules – capital, RWAs Yes
resilient banks and banking systems
Basel III: International framework for liquidity risk 16 December 2010 Key Basel III rules – liquidity Yes
measurement, standards and monitoring
Revisions to the Basel II market risk framework – final 13 July 2009 (updated February 2011) Key Basel 2.5 rules (market risk) Yes (superseded by 14 January 2016 “Minimum capital
version requirements for market risk”, go-live January 2019)
Enhancements to the Basel II framework 13 July 2009 Key Basel 2.5 rules Yes
Basel II: International Convergence of Capital 10 June 2004; updated 15 November 2005, 30 June Key Basel II rules – capital, RWAs No (superseded by Basel III rules)
Measurement and Capital Standards: A Revised 2006
Framework
International convergence of capital measurement and 4 July 1988 (updated April 1988) Key Basel I rules – capital, RWAs No (superseded by Basel II rules; Basel III transitional
capital standards capital floor based on Basel I RWAs)

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Annex 2: Revised SA Credit Risk-Weightings Retail exposures excluding real estate

Regulatory retail (revolving)
Exposures to banks where the ratings approach is permitted Regulatory retail (non-
revolving) Transactors Revolvers Other retail
BBB+ to
Risk weight 75% 45% 75% 100%
External rating AAA to AA– A+ to A– BBB– BB+ to B– Below B– Unrated
Risk weight 20% 30% 50% 100% 150% As for SCRA below Residential real estate exposures
Short-term exposures Below 50% to 60% to 70% to 80% to 90% to above
Risk weight 20% 20% 20% 50% 150% As for SCRA below LTV bands 50% 60% 70% 80% 90% 100% 100% Criteria not met
General RRE
Exposures to Banks where the ratings approach is not permitted and for unrated exposures
Whole loan
Standardised Credit Risk Assessment Approach (SCRA) grades Grade A Grade B Grade C 20% 25% 30% 40% 50% 70% RW of counterparty
approach RW
Risk weight 40%1 75%1 150% Loan-splitting
20% RW of counterparty RW of counterparty
Short-term exposures 20% 50% 150% approach2 RW
Income-producing residential real estate (IPRRE)
Exposures to covered bonds risk-weights for rated covered bonds
Whole loan
30% 35% 45% 60% 75% 105% 150%
External issue-specific rating AAA to AA– A+ to BBB– BB+ to B– Below B– approach RW
Risk weight 10% 20% 50% 100% Commercial real estate (CRE) Exposures
Risk weights for unrated covered bonds LTV ≤ 60% LTV > 60% Criteria not met
Whole loan approach
Risk weight of issuing bank 20% 30% 40% 50% 75% 100% 150% Min (60%, RW of counterparty) RW of counterparty RW of counterparty
Risk weight 10% 15% 20% 25% 35% 50% 100% LTV ≤ 55% LTV > 55% Criteria not met
Loan-splitting approach2
Exposures to general corporates where the ratings approach is permitted Min (60%, RW of counterparty) RW of counterparty RW of counterparty
Income-producing commercial real estate (IPCRE)
External rating of BBB+ to
counterparty AAA to AA– A+ to A– BBB– BB+ to BB– Below BB– Unrated LTV ≤ 60% 60% < LTV ≤ 80% LTV > 80% Criteria not met
Whole loan approach
Risk weight 20% 50% 75% 100% 150% 100% or 70% 90% 110% 150%
85% if corporate SME Land acquisition, development and construction (ADC) exposures
Exposures to general corporates where rating approach is not permitted Loan to company/SPV 150%
Residential ADC loan 100%
Investment grade All other
Subordinated debt and equity (excluding amounts deducted)
General corporate (non-SME) 65% 100%
Subordinated debt and Equity exposures to
SME general corporate 85%
capital other than certain legislated “Speculative unlisted All other equity
Exposures to project finance, object finance and commodities finance equities programmes equity” exposures
Risk weight 150% 100% 400% 250%
Exposure (excluding real estate) Project finance Object and commodity finance
Credit conversion factors for off-balance sheet exposures
Issue-specific ratings available and
Same as for general corporate (see above) ST self-liquidating trade
permitted
NIFs and RUFs, and letters of credit arising Direct credit substitutes
Rating not available or not permitted 130% pre-operational phase Commitments, certain transaction- from the movement of and other off balance
100% operational phase 100% UCCs except UCCs related contingent items goods sheet exposures
80% operational phase (high quality)
CCF 10% 40% 50% 20% 100%
Source: Fitch Ratings, Basel Committee on Banking Supervision (December 2017)

Banks - Regulation
Global
as the weighted average of the buffers in effect in the jurisdictions to which banks have a credit
Annex 3: Regulatory Glossary exposure.
Additional Tier 1 (AT1) Capital: Instruments with features of equity and debt – ie hybrid
instruments, which provide a cushion against losses on a going-concern basis, by being written down Counterparty Credit Risk (CCR): In the context of derivatives and repo-style products, the bilateral
or converted into common equity Tier 1 at a regulatory-defined point of non-viability. In certain risk of loss to either counterparty, depending on the market value of the transaction at a point in
circumstances, coupon distributions are subject to mandatory (regulatory) restrictions. time.
Asset-Backed Commercial Paper (ABCP): An asset-backed tradeable security with a tenor typically Correlation Trading Portfolio (CTP): Refers to securitisation exposures where: (a) the positions are
between 90 and 180 days. neither resecuritisation positions, nor derivatives of securitisation exposures that do not provide a
pro-rata share in the proceeds of a securitisation tranche; and (b) all reference entities are single-
Available for Sale (AFS): An accounting classification used for financial assets that do not qualify for name products, including single-name credit derivative contracts, for which a liquid two-way
classification as “held for trading” or “held to maturity”. market exists.
Available Stable Funding (ASF): In the context of the NSFR liquidity standards, liabilities that Credit Spread Risks in the Banking Book (CSRBB): A risk closely associated with IRRBB, arising
represent stable funding sources for the bank, compared with RSF. Each type of liability is assigned from variations in the premium that the market requires for different types of instrument, reflecting
an ASF factor to determine the extent it can contribute to the bank’s funding needs. both credit and other market risks, such as liquidity.
Bank of International Settlements (BIS): The BIS promotes international cooperation among Credit Valuation Adjustment (CVA): A Pillar 1-based capital charge, to capture the risk of potential
monetary authorities. Its customers are central banks and international organisations. market value losses on derivative transactions, due to the credit migration of the counterparty.
Basel Committee on Banking Supervision (BCBS): The global standard-setter for the prudential Current Exposure Method (CEM): A relatively antiquated method of estimating the EAD associated
regulation of banks and issuer of the Basel Accords on bank prudential supervision. Its mandate is with the CCR arising from a derivative contract.
to strengthen the regulation, supervision and practices of banks worldwide with the purpose of
enhancing financial stability. Deferred Tax Assets (DTAs): These arise when a bank makes big enough losses that its tax bill is
reduced not only in the current year but also potentially in future years. While DTAs used to count
Basel III: Sets minimum capital requirements for internationally active banking organisations, as regulatory Tier 1 capital under Basel II, Basel III phases out DTAs arising from past losses as
issued by the BCBS in December 2010. Basel III introduced a number of amendments to the prior regulatory capital.
framework (Basel II, first issued in 2004, and Basel 2.5, issued in 2009) including raising the quantity
and quality of capital requirements, introducing various capital buffers, new liquidity standards and Expected Loss (EL): In the context of regulatory capital, the average level of credit losses a bank can
an LR constraint. reasonably expect to experience as a cost of doing business. Specifically in the context of the IRB
approach, EL = PD * EAD * LGD.
Capital Conservation Buffer (CCB): A CET1-based capital buffer to ensure that banks build up
capital buffers outside periods of stress, which can be drawn down as losses are incurred. Capital Expected Shortfall (ES): A statistical measure of the expected values of all changes in the portfolio
distribution constraints will be imposed on a bank if CET1 levels pierce the buffer. value in the tail of the P&L distribution, conditional on these changes exceeding the VaR (“if things
get bad what is our expected loss”). Also known as conditional VaR.
Central Clearing Counterparty (CCP): Also known as a clearing house, where it becomes the buyer
to every seller, and seller to every buyer. A CCP also nets transactions between its members on a Exposure at Default (EAD): An estimate of the extent to which a bank may be exposed to a
multilateral basis (also for cash payments), producing smaller net exposures. counterparty in the event of credit default. The assessment basis of EAD varies depending on
whether the standardised or IRB approach to credit risk is used.
Commercial Paper (CP): Short-term unsecured promissory notes issued by companies.
Financial Stability Board (FSB): An international body that monitors and makes recommendations
Common Equity Tier 1 (CET1): Essentially tangible common equity and retained earnings, excluding about the global financial system, issues international standards for effective resolution regimes,
intangibles and with additional adjustments to accounting items (including prudential deductions). and jointly issues with the BCBS the annual list of G-SIBs.
Forms part of the “Tier 1” going-concern capital resources of a bank.
Gross Domestic Product (GDP): A measure to estimate the economic output of an economy. Used
Countercyclical Capital Buffer (CcyB): CET1-based capital buffer to protect the banking sector in the context of the CcyB rate to determine the deviation of the ratio of credit to GDP from its long-
from periods of excess aggregate credit growth, set individually by national authorities. Calculated term trend (i.e. the extent of excess credit growth).

Banks - Regulation
Global
Global Systemically Important Bank (G-SIB): A G-SIB is defined as a bank whose distress or Loss Given Default (LGD): The proportion of asset value that is lost when a borrower defaults. The
disorderly failure, because of its size, complexity and systemic interconnectedness, would cause recovery rate is defined as 1 minus the LGD, i.e. the share of an asset that is recovered when a
significant disruption to the wider financial system and economic activity. G-SIBs are formally borrower defaults. Used as a parameter within the IRB credit risk approach.
designated annually by the FSB, using criteria from the BCBS.
Mortgage Servicing Rights (MSR): A contractual agreement where the right, or rights, to service an
Going-Concern Capital: Going-concern capital absorbs losses before a bank becomes non-viable existing mortgage are sold by the original lender to another party (servicer). In return, the servicer
and either defaults or avoids default because it is supported. CET1 and AT1 instruments are the receives a fee. Unlike other intangible assets, they are only partially deducted from CET1.
most common forms of going-concern capital.
Net Stable Funding Requirement (NSFR): A longer-term structural liquidity standard that aims to
Gone-Concern Capital: Gone-concern capital absorbs losses in an end-game scenario (eg when a ensure that a bank maintains a stable funding profile in relation to the composition of its assets and
bank is placed into resolution or becomes insolvent). Tier 2 debt instruments are the most common off-balance-sheet activities.
forms of gone-concern capital.
Over-the-Counter (OTC) Derivative: Contracts that are traded (and privately negotiated) directly
Group of Governors and Heads of Supervision (GHOS): The body that supervises and approves the between two parties, without going through an exchange or other intermediary.
work of the BCBS. Its members comprise central bank governors and finance ministers from the 27
Probability of Default (PD): A parameter used in the context of the IRB approach to credit risk that
BCBS member states.
provides an estimate of the likelihood that a borrower will be unable to meet its debt obligations
High-Quality Liquid Assets (HQLA): Unencumbered cash, or assets that can be converted into cash at when due, over a given time horizon.
little or no loss of value in private markets to meet LCR requirements.
Required Stable Funding (RSF): In the context of the NSFR liquidity standards, assets that require
Interest Rate Risk in the Banking Book (IRRBB): The current or prospective risk to the bank’s stable funding sources for the bank (compared to ASF). Each type of asset is assigned an RSF factor
capital and earnings arising from adverse movements in interest rates that affect a bank’s banking to determine its funding needs.
book (ie non-traded) positions.
Risk-Weighted Assets (RWAs): Weights assigned to assets based on the risk sensitivity of each
Internal Ratings Based (IRB): Approach to determine credit risk capital requirements based on the asset class. RWAs represent the denominator of many capital ratios. Therefore, higher RWAs
use of internal PD, LGD and maturity estimates. require greater capital levels.
International Monetary Fund (IMF): An international organisation designed to foster global monetary SEC-ERBA: The “Securitisation External Ratings-Based Approach” in the context of the 2014
cooperation, secure financial stability, facilitate international trade and reduce poverty. revised securitisation framework.
KIRB: IRB capital requirements for the underlying pool of securitised assets assuming they had not SEC-IRBA: The “Securitisation Internal Ratings-Based Approach” in the context of the 2014 revised
been securitised. securitisation framework.
Large Exposures (LE): A prudential regime for limiting banks’ single-name credit concentration risk, SEC-SA: The “Securitisation Standardised Approach” in the context of the 2014 revised
defined as a credit exposure to a single counterparty, or a group of related counterparties exceeding securitisation framework.
10% of a bank’s eligible capital base.
Securities Financing Transaction (SFT): Repurchase agreements, reverse repurchase agreements,
Leverage Ratio (LR): A non-risk-based balance-sheet constraint, calculated by dividing Tier 1 capital security lending and borrowing, and margin lending transactions, where the value of the
by the bank’s average total consolidated assets. Banks are expected to maintain a leverage ratio in transactions depends on market valuations, and margin agreements usually apply.
excess of 3% under Basel III.
Special-Purpose Vehicle (SPV): A legal entity created to fulfil narrow, specific or temporary
Liquidity Coverage Ratio (LCR): A short-term liquidity standard that aims to ensure that a bank has objectives, typically used to isolate financial risk.
a stock of cash, or assets that can be converted into cash during a 30-day stress period with little or
Standardised Approach to Counterparty Credit Risk (SA-CCR): Used since January 2017 to
no loss of value.
estimate counterparty credit risk exposures for derivatives under Basel III (replacing the existing
Loan to Value (LTV): A ratio of the loan (numerator) to the value of asset being financed non-modelled exposure measurement methods).
(denominator).

Banks - Regulation
Global
Small to Medium Enterprise (SME): In the context of the BCBS regime, a sub-exposure class of
corporate. It is defined as a borrower where the reported sales for the consolidated group is less
than EUR50 million.
Standardised Approach (SA): Use of prescribed regulatory rules to determine RWAs.
Standardised Measurement Approach (SMA): Methodology for the calculation of operational risk
capital requirements under the final Basel III standard. Its key drivers include the absolute values of
net income or loss and historical operational loss experience.
Structured Investment Vehicle (SIV): A non-bank legal entity (typically an SPV) that buys long-term
assets, funding this by issuing short- or medium-term debt to earn a spread.
Supervisory Formula Approach (SFA): An IRB model approach to estimate regulatory capital for
exposures to securitisation programmes lacking a credit rating.
Total Loss Absorbing Capacity (TLAC): TLAC is intended to ensure banks have sufficient capacity
to absorb losses both before and during resolution. TLAC broadly includes equity and liabilities that
can be legally written down or converted to equity in case of resolution.
Unexpected Loss (UL): In the context of regulatory capital, losses above expected levels are usually
referred to as Unexpected Losses. From an IRB credit risk perspective, subtracting EL from the
conditional expected loss for an exposure yields the “UL-only” capital requirement.
Value-at-Risk (VaR): A statistical measure of the potential loss in value of a risky asset or portfolio
over a defined period (10 days for Basel III market risk), for a given confidence interval (99.0% for
Basel III).

Banks - Regulation
Global
Annex 4: Pillar 1 Banking Book vs Trading Book Assignment – Reflecting Final Basel III “Endgame” Revisions
Non-Trading/Banking Book – the following instruments may not be held in the trading book, and Trading Book – instruments held for one of more of the following purposes are subject to
therefore will be subjected to the credit risk regime: market/counterparty credit/CVA risk regimes:
• Unlisted equities • Short term resale;

• Instruments designated for securitisation warehousing • Profiting from short-term price movements;
• Real estate holdings • Locking in arbitrage profits;
• Retail and SME credit • Hedging risks that arise from instruments above
• Equity investments in any fund (unless (i) daily • Any instrument that is managed on a “trading desk”
• price quotes are available; (ii) track a non-leveraged benchmark; and (iii) demonstrate an • Any instrument giving rise to a net short credit or equity position in the banking book
absolute tracking difference value of <1%, ignoring fees and commissions) • Any instruments resulting from underwriting commitments.
• Derivative instruments that have the above instrument types as underlying assets; or
• Instruments held for the purpose of hedging a particular risk of a position in the types of There is a general presumption the following instruments are trading book positions, unless
instrument above explicit supervisory permission is obtained to deviate and hold within the banking book:
• Accounting trading assets or liabilities

Key Capital Charges • Positions resulting from market-making activities
• Equity investment in transparent funds
Credit Risk • Listed equities
• Trading-related repo-style transactions
• Options that relate to credit or equity risk
Interest Rate Risk in Banking Book (Pillar 2)
Key Capital Charges
Traded Market Risk
Counterparty Credit Risk
Credit Valuation Adjustment Risk

Banks - Regulation
Global
Annex 5: Basel III Credit Risk Approaches – Reflecting Final Basel III “Endgame” Revisions
Credit Risk (Banking Book) – Final Basel III Endgame Rules
Revised Standardised Approach (SA) Internal Ratings Based Approach (IRB)
Corporates, Bank, Real Estate Retail, Sub- Securitisation Securitisation Large Corporate, Corporates – Retail, Specialised
Sovereigns, Debt, Equities, IRBA FIs Excluding Large Mortgage, Lending
Securitisation Other Assets Corporates FIs Revolving, Other
• Corporate w/ • Project/object/
• Risk weights based • Fixed risk Risk-weight revenue >€500m, • Mid-corporate
• Fixed commodity
on external credit weights, vary supervisory based on the IRB all banks, (annual revenue • PD and LGD finance, typically
ratings, or by loan-to- risk weights capital charge Insurance, NBFIs <€500m), SME, (or EL) via SPV structure
standardised credit value and had the CRE, Sovereign estimated
assessment (for loan purpose underlying using varying
claims on banks, • Land External Standardised IRB formulae
corporates) acquisition, Ratings Based Approach exposures not
• Bank credit ratings Development Approach been securitised
cannot reflect and • If credit (KIRB), tranche Foundation Advanced
rating Foundation IRB Advanced IRB
sovereign support Construction Risk weights attachment point IRB IRB
• Supervisory risk exposures based on approach
external cannot be (A), tranche • PD estimated • PD, LGD, EAD
weights if unrated fixed risk • PD • PD, LGD,
credit used detachment point by banks estimated by estimated by EAD, and
weights
ratings (if • Based on (D), supervisory • LGD and bank bank M
permitted in underlying parameter (P), maturity • Maturity is • LGD and estimated
jurisdiction) pool and based on set between 1 maturity by bank
tranche tranche maturity
measures and 5 years based on set
attributes measures
IRB Internal Ratings Based

PD Probability of Default Supervisory Slotting
LGD Loss Given Default
M Effective Maturity • If unable to estimate risk inputs
EAD Exposure at Default internally, then must map
SME Small-and Medium-sized Enterprises internal ratings to supervisory
CRE Commercial Real Estate buckets with fixed risk weights
RE Real Estate
EL Expected Loss
Source: Fitch Ratings, Basel Committee on Banking Supervision

Banks - Regulation
Global
Annex 6: Basel III Credit Risk Mitigation – Reflecting Final “Endgame” Revisions
Credit Risk Mitigation – Final Basel III Endgame Rules
Banks use a number of techniques to mitigate the credit risks to which they are exposed. For example, exposures may be collateralised by first priority claims, in whole or in part with cash or securities, a loan exposure may be
guaranteed by a third party, or a bank may buy a credit derivative to offset various forms of credit risk.
Repo-Style Transactions
Collateral Guarantees & Credit Derivatives
• Objective of methodologies is to determine a net exposure
amount, taking into account the price volatility on each leg of the
transaction
• Can incorporate the effects of legally-effective bilateral netting
agreements (including cross-product netting)
• Minimum haircut floors apply for non-centrally cleared reverse-
repos over non-government collateral, or similar collateral
upgrade trades, when facing unregulated counterparties
Standardised IRB Approach Standardised IRB Approach Haircuts VaR Model Internal Model Method
• Reflects price
• Financial collateral only (i.e., no • Permits the incorporation of any •TheRisk weight
protected • There are two approaches for • Supervisory or volatility of • Expected Positive
recognition of physical collateral) financial and physical collateral, of guarantor
portion is recognition of CRM: a foundation internally estimated exposure and Exposure (EPE)
• Based on prescribed supervisory rules provided minimum operational, legal substitutes
assigned the approach using supervisory LGDs, • Gross up exposure collateral • Similar
and calculation processes and other requirements are met for
risk weight of and an advanced approach using and reduce value of • Requires methodology as
counterpart
the protection own internal estimates of LGD eligible collateral to internal market model-based
y risk weight
provider. • Either method must not reflect the reflect supervisory risk model approach for OTC
effect of double-default price volatilities approval derivatives
Simple Comprehensive Foundation IRB Advanced Foundation IRB Advanced IRB

• Substitute • Volatility-adjusted Exposure weighted
• For financial •OwnOwninternal
estimates • Eligible providers per • Direct adjustment to
exposure risk exposure minus average of LGD
collateral, for
apply estimates
of risk of LGD, standardised approach either PD or LGD
weight by haircut value of unsecured exposure
Comprehensive subject to
mitigation (eg. • Substitution of risk- • Compared to the
collateral risk collateral (LGDU) and LGD
approach for parameter floors
LGD estimates) weight function of Foundation
weight • Eligible collateral applicable to the
Standardised (for unsecured, protection provider for approach, there are
• Eligible collateral- per Simple, plus: collateralised
banks part of and secured, covered portion, PD of no limits to the range
cash, gold, min BB- non-main index an
• exposure, based
For physical varying by protection provider of eligible guarantors,
sovereign debt, equities/ on supervisory LGDs
collateral, apply collateral type) • LGD of transaction may provided minimum
min BBB- other convertibles, andLGD
haircut values
adjustment, be replaced with LGD requirements are
debt, main index listed mutual subject to a floor applicable to satisfied.
equities funds guarantee/CDS
IRB Internal Ratings Based
OTC Over the Counter
PD Probability of Default
LGD Loss Give Default
VaR Value at Risk
Source: Fitch Ratings, Basel Committee on Banking Supervision

Banks - Regulation
Global
Annex 7: Basel III Revised Market Risk Framework – Standardised Approach Changes
Current SA - Until End Dec 2022 Current Market Risk Standardised Method
• Derive net position for general and
specific risks
• Calculate interest rate sensitivity to
duration and delta sensitivity for
options General Market Risk
Specific Market Risk
• Multiply by capital weightings capital charge
IR: Maturity method (weight by maturity banks / zones

/ Coupon) or duration method, * IR changes FX /
Equity: generally 8% multiplier
Commodities: variable % multiplier
Revised SA - From Jan 2023 Revised Market Risk Standardised Method – Sensitivity Based Approach (SBA)
1 Enhanced Delta Plus capital charge:
• Derive net position for 7 assets

• Map assets to market risk factors (“greeks”) 1 2 3
• Shocks applied compute capital
Enhanced delta plus Default risk capital
• Pricing model determines size of risk risk capital charge
Residual Risks add-on
charge
positions
• Risk weighted sensitivities aggregated into
risk buckets
• Aggregate bucket-level charges to
determine asset class-level charges
• Aggregate asset class charges
1a 1b
2 (Jump-to) Default Risk Charge:
Linear risk Capital Non-linear risk capital
charge charge
• Notional/face value *LGD+P&L (delta and vega) (curvature)
• Derive net jump-to-default
• Apply default RW per banking book
Residual Risks add-on charge:

3 Max (Notional* 0.1%/1% or max loss)

Banks - Regulation
Global
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Financial Institutions

Basel III Field Guide – Updated to Reflect Final “Endgame” Rules

Special Report │ 12 November 2021 fitchratings.com 1

Introduction Impact of Basel III and “Basel IV” on Banks

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One Pager: Basel III Reform Summary

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One Pager: Key Quantitative Requirements/Trip-Wires Key RWA-Based Requirements

Large Exposure Tier 1 + min (Tier 2, 1/3 Tier 1)

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“Fully Loaded” International Basel III Capital (Numerator) Requirements

Fully-Loaded (2019) Capital Requirements, for Select International Jurisdictions

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One Pager: Basel III Transition Timeline/Effective Date of Finalised Reforms

Basel III “Endgame” Transition Timeline/Effective Date of Finalised Reforms

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Element Risk description

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Source: Fitch Ratings

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The Standardised/Non-Modelled Approaches to Calculate RWAs

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Operating/Fee Income Internal Ratings-Based Approach (IRB), Credit Risk

The Internal Model Approaches Derivatives: OEM/CEM/IMM Maturity (M)

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Internal Models Approach (IMA) – Market Risk

Trading book risk positions/instruments (including trading book Netting/collateral

Compre- Historic External Forward-

RWA = 12.5* [ Regulatory capital requirement calculation ]

Diversification benefits allowed (so capital charge is not simple sum

Source: Fitch Ratings

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2. The securitisation external ratings-based approach (SEC-ERBA) assigns risk weights

Excessively high risk-weights for low-rated senior securitisation exposures;

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Primer: Liquidity Coverage Ratio Overview: LCR Components

Source: Fitch Ratings

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Annex 1: Basel III-Related External Bibliography

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Annex 1: Basel III-Related External Bibliography (Cont)

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Annex 2: Revised SA Credit Risk-Weightings Retail exposures excluding real estate

Source: Fitch Ratings, Basel Committee on Banking Supervision (December 2017)

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• Unlisted equities • Short term resale;

• Accounting trading assets or liabilities

Key Capital Charges

Traded Market Risk