The Basel II Capital Accord: June 2005

The Basel II Capital Accord
June 2005
Table of Contents
Chapter 1 – Basel basics

Executive Summary 7
Basel I overview 8
Basel II overview
Timing 9
Scope of application 10
Capital components 13
Types of Banks 14
IRB Transition Period 16
Chapter 2 – Basel II minimum capital charges – First Pillar
Sovereign exposures 18
Bank exposures 21
Corporate exposures 24
Retail exposures 27
Real estate exposures 30
Covered bonds 33
Specialised lending 34
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Table of Contents (cont’d)
Chapter 2 – Basel II capital charges (cont’d)

Off-balance sheet items 35
Equity 37
Non-performing loans 39
Credit risk mitigation (CRM) 45
Securitisation exposures
Standardised banks
- Ratings based approach 51
- Most senior exposures; second loss positions or better 52
- Liquidity facilities 53
- Overlapping exposures 55
IRB banks
- Ratings based approach 57
- Internal assessments approach 58
- Supervisory formula approach 61
- Liquidity facilities 63
- Top-down approach 64
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Chapter 2 – Basel II capital charges (cont’d)

Early amortisation structures 66
Trading book 71
Chapter 3 – Basel II operational risk charges 84

Basic indicator approach
Standardised approach
Advanced measurement approach
Chapter 4 – Supervisory Review – Second Pillar

Four key principals of supervisory review 87
Supervisory review process for securitisation 89
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Chapter 5 – Market discipline – Third Pillar

Qualitative disclosure 92
Quantitative disclosure 93
Chapter 6 – Some observations

Open issues 95
Impact on financial markets 96
Impact on banks 97
Impact on securitisation markets 98
Impact on ABCP conduits 99
Contact Details 100
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Chapter 1
Basel II Basics
Executive Summary
Basel II introduced to:

Basel I  In effect since 1988; very simple in application
 combat regulatory arbitrage
 Easy to achieve significant capital reduction with little or no risk transfer
 exploit and improve bank risk
management systems
 Much more complex and risk sensitive

First Pillar – Minimum capital Will profoundly alter bank
Basel II behaviour
Second Pillar – Supervisory review
Third Pillar – Market discipline
 Treats exposures very unequally
depending on exposure
characteristics
 Treats banks very unequally
depending on sophistication of risk
management systems
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Basel I – Capital Charges
Risk weights
 OECD sovereigns: 0%
 OECD banks: 20%
 Residential mortgages: 50%
 Synthetic: 20% super-senior, 0% cash-collateralised mezzanine, deduction or 100%
first loss (with national variations)
 Unfunded commitments under one year: 0%
 Unfunded commitments over one year: 50%
 Everything else: 100%
Sample capital calculation
 €100 million corporate exposure
 100% risk weight = €100 million risk weighted assets (RWA)
 Capital charge = Capital = 8% minimum
RWA
 Capital charge: €8 million
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Basel II – Timing
Basel II However
 Published June 2004  New rules will alter banks’ behaviour right
 End 2006 for standardised and foundation away
IRB banks (¶ 2)  Some countries will adopt prior to expected
 End 2007 for advanced IRB banks (¶ 2) implementation dates, at least in part
 End 2009 (at earliest) before full IRB benefits  Implementation may be delayed in some
achievable due to transition period (¶¶ 45-49) countries
 Basel/IOSCO review (not yet final) will  Reaction of US regulators to QIS 4 results
change CRM rules and rules for trading may cause delays
book exposures  EU and member state adoption schedules
not usually so quick
Capital Requirements Directive (CRD)
 Implementation may not be uniform
 Will implement Basel II within EU
 140+ items subject to national discretion
 Same adoption timing sought
 Supervisory discretion
 May vary from Basel II (and thus from rules in
US and elsewhere) in important respects  Lengthy adoption time permits lobbying
Unless otherwise indicated, all references to paragraph numbers in

these materials refer to paragraphs in June 2004 Basel II Accord
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Basel II – Scope of Application
Applied on consolidated basis to Insurance entities

internationally active banks (¶ 20)*  Generally, deduct bank’s equity and other capital
 All banking and other financial activities investments in insurance subsidiaries (¶ 30)
(whether or not regulated) captured  However, some G10 countries will retain current risk
through consolidation (¶ 24) weighting treatment (100% for standardised banks) for
 Financial activities do not include competitiveness reasons (¶ 31)
insurance (¶ 24, fn. 5)  Supervisors may permit recognition by bank of excess
 Majority-owned subsidiaries not capital invested in insurance subsidiary over required
consolidated: deduct equity and capital amount (¶ 33)
investments (¶ 27) Commercial entities
 Significant minority investments without  generally deducted significant investments in
control: deduct equity and capital commercial entities above materiality thresholds (¶ 35)
investments (¶ 28)
 Significant investments in commercial entities below
 Deduction of investments 50% from tier 1
materiality thresholds risk weighted 100% (¶ 36)
and 50% from tier 2 capital (¶ 37)
* EU rules (CRD) will also apply to solo entities and to
investment firms
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Basel II – Capital and Provisions
Definition of regulatory capital unchanged (¶ 41) (but some changes anticipated going forward)
Treatment of provisions
 Standardised approach: general provisions can be included in tier 2 capital up to limit of 1.25%
of risk-weighted assets (¶ 42)
 IRB approach:
 Securitisation and certain equity exposures: expected loss (EL) amount must first be
deducted from capital (¶ 43)
 Other exposures: bank must compare total eligible provisions against total EL amount and
deduct any excess EL amount over eligible provisions (excess of provisions over EL amount
may be added to tier 2 capital up to maximum of 0.6% of risk-weighted assets (¶ 43, ¶¶ 374-
386)
Scaling Factor
 Scaling factor of 1.06 (subject to recalibration following QIS 4 and QIS 5) introduced to ensure
same aggregate amount of capital remains in banking system following Basel II adoption (¶ 44,
fn. 11)
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Basel II – Three Pillars
Minimum Capital Charges: Minimum capital requirements based on market, credit

and operational risk to (a) reduce risk of failure by cushioning against losses and (b)
First Pillar
provide continuing access to financial markets to meet liquidity needs, and (c) provide
incentives for prudent risk management (¶¶ 40-718)
Supervisory Review: Qualitative supervision by regulators of internal bank risk control

Second Pillar and capital assessment process (¶¶ 719-807), including supervisory power to require
banks to hold more capital than required under the First Pillar
Market Discipline: New public disclosure requirements to compel improved bank risk
Third Pillar
management (¶¶ 808-822)
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Basel II – Capital Components
Credit risk charges (¶¶ 40-643)

 Revised
 To ensure capital charges are more sensitive to risks of exposures in banking book
 Enhancements to counterparty risk charges also applicable to trading book exposures
Operational risk charges (¶¶ 644-683)

 New
 To require capital for operating risks (fraud, legal, documentation, etc.)
Market risk charges (¶¶ 684-718)

 Initially unchanged, but Basel/IOSCO review has proposed changes to specific risk
calculations and Second Pillar stress testing
 To require capital for exposures in trading book
 Rules in Market Risk Amendment (1996)
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Basel II – Types of Banks
 Measure credit risk pursuant to fixed risk weights based on external credit assessments
(ratings)
Standardised  Least sophisticated capital calculations; generally highest capital burdens
 Most Japanese banks will start Basel II as standardised banks
 Most US banks will stay under Basel I (or, more likely, will move to Basel 1½)
 Measure credit risk using sophisticated formulas using internally determined inputs of
probability of default (PD) and inputs fixed by regulators of loss given default (LGD), exposure
Foundation IRB at default (EAD) and maturity (M).
 More risk sensitive capital requirements
 Most European banks will likely qualify for Foundation IRB status at start of Basel II
 Measure credit risk using sophisticated formulas and internally determined inputs of PD, LGD,
EAD and M
Advanced IRB
 Most risk-sensitive (although not always lowest) capital requirements
 Transition to Advanced IRB status only with robust internal risk management systems and
data
 Top 10 US banks expected to implement Advanced IRB at start of Basel II
Under Basel II, banks have strong incentive to move to IRB status and reduce capital
charges by improving risk management systems
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External Ratings Criteria
External credit assessment institution (ECAI)(rating agency) recognised/

Recognition approved by national supervisor on basis of objectivity, independence,
transparency, disclosure, resources and credibility (¶ 91)
If two assessments, higher risk weight applied (¶ 97)

Multiple If three or more assessments, two lowest risk weights referred to and
ratings higher of those two applied (¶ 98)
Ratings assessment must take into account entire exposure (principal only
Assessment
ratings will not qualify) (¶ 100)
Credit risk mitigation (CRM) not recognised if taken into account in rating
CRM (¶ 101)
Solicited Subject to national discretion, unsolicited ratings recognised (¶ 108)
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Transition Period (IRB Banks only)
Foundation IRB capital requirements for credit risk, operational risk and market risk may
2007
not fall below 95% of the current minimum required for credit and market risks (¶ 46)
IRB capital requirements for credit risk, operational risk and market risk
2008 may not fall below 90% of the current minimum required for credit and
market risks (¶ 46)
IRB capital requirements for credit risk, operational risk

2009 and market risk may not fall below 80% of the current
minimum required for credit and market risks (¶ 46)
BIS Committee and/or national

2010
supervisors may extend floor if warranted
and after
(¶ 48)
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Chapter 2
Basel II – First Pillar
Minimum Capital Charges
Basel II – Sovereign Capital Charges
Sovereigns – In a Nutshell
Basel I Basel II
Type of
Risk Weight Standardised bank risk weights Sample est. FIRB bank risk weights* Rating
Sovereign
AA- or
OECD 0% above 0% 25%
Poland A2/BBB+
non- A
100% 20%
External Rating
OECD Russia 68% Baa3/BBB-
Country
BBB 50% Turkey 141% B1/BB-
BB+ to
B- 100% Bulgaria 100% Ba1/BBB-
below B- 150% Czech Republic 24% A1/A-
unrated 100% Hungary 24% A1/A-
* Inputs: average rating agency values

Winners Losers for PD, LGD of 45%, supervisory
 non-OECD rated  OECD rated below value for EAD and M of 2.5. (Moody’s
rating applied if different from S&P)
above BB+ AA-
 Examples: Chile,  Examples: Czech
China, Thailand Republic, Greece,
Hungary, Mexico,
Turkey
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Sovereigns – Standardised Banks (¶¶ 53-59)
 Risk weights for sovereign exposures:
AAA to A+ to BBB+ BB+ to Below

Rating Unrated
AA- A- to BBB- B- B-
Risk Weight 0% 20% 50% 100% 150% 100%
 Risk weights may also be based on ECA risk scores

 Claims on non-central government public sector entities based on corporate exposure risk
weights
 Claims on multilateral development banks have 0% risk weight if conditions are met,
including: (i) majority of MDB’s ratings are AAA, (ii) significant portion of shareholders are
AA- or better rated sovereigns, (iii) funding is in form of paid-in equity with little or no
leverage, and (iv) conservative lending criteria
 At national discretion, lower risk weight for banks’ exposures to their sovereign (or central
bank) in domestic currency; if adopted, other regulators may permit same risk weight
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Sovereigns – IRB Banks (¶¶ 270-272)

 Formula for exposure not in default:
Correlation (R) = 0.12 × (1 – EXP (-50 × PD)) / (1 – EXP (-50)) +
0.24 × [1 - (1 - EXP(-50 × PD))/(1 - EXP(-50))]
Maturity adjustment (b) = (0.11852 – 0.05478 × ln (PD))^2
Capital requirement (K) = [LGD × N [(1 - R)^-0.5 × G (PD) + (R / (1 - R))^0.5 × G
(0.999)] – PD x LGD] x (1 - 1.5 x b)^ -1 × (1 + (M - 2.5) × b)
Risk-weighted assets (RWA) = K x 12.5 x EAD
 Capital requirement for defaulted exposure equals greater of zero and difference between exposure’s
LGD and bank’s best estimate of loss
 Input characteristics (applicable to all types of exposures) (¶¶ 285-325):
 PD: internally determined one-year probability of default
 LGD:
- FIRB: 45% (senior)/75% (subordinated); adjusted (LGD* = LGD x (E* / E) for CRM recognition
- AIRB: own estimates; adjusted for CRM recognition
 EAD: not less than sum of (a) amount by which bank capital would reduce if exposure written-off
fully and (b) specific provisions and partial write-offs
 M: 2.5 years for FIRB (6 months for repos); own est. for AIRB for each exposure; max. 5 years
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Basel II – Bank Capital Charges
Banks – In a Nutshell
Basel I Basel II
Type of Standardised Standardised
Risk Weight FIRB est. risk weights*
Bank Option 1 Option 2
OECD AA- or AA- or
20% 20% 20% 14% - 24%
above above
non-
100% A+ to A- 50% 50% A+ to A- 24% - 28%
External Rating
OECD
External Rating
BBB+ to BBB+ to
BBB- 100% 50% 38% - 68%
BBB-
BB+ to
B- 100% 100% BB+ to B- 100% - 197%
below B- 150% 150% below B- 226%
unrated 100% 50% Unrated*** NA
* Using inputs of average rating agency

Winners Losers values for PD, LGD of 45%,
supervisory value for EAD and M of
 non-OECD rated above  OECD rated A or below 2.5.
BB+ under Option 2 under either option ** Using inputs of rating agency values
for PD, LGD of 10%, supervisory
 Examples: May Bank,  Examples:
value for EAD and M of 2.5.
Public Bank Berhad Commerzbank, HVB,
*** Internal PD estimate to be applied.
SEB, Mizuho, Bradesco
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Banks – Standardised Banks (¶¶ 60-65)

2 options, selected by national regulator to apply for all banks in jurisdiction:
 Option 1: Banks risk weighted one category below risk weights of banks’ sovereigns:

Rating Unrated
Risk Weight 20% 50% 100% 100% 150% 100%
 Option 2: At national discretion, banks risk weighted on basis of own external ratings (plus
more favourable risk weight if claim maturity < 3 months)
Rating Unrated
Risk Weight 20% 50% 50% 100% 150% 50%
 Local currency reduction: National regulators may reduce by one notch risk weight of local
currency bank debt having maturity of less than 3 months, subject to floor of 20%
 Exposures to securities firms treated as bank claims if regulatory arrangements
comparable
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Banks – IRB Banks (¶¶ 270-272)

 Formulas for bank exposures same as for sovereign exposures, but with floor for PD of 0.03%
 Effective floor of 16 to 48 basis points for highest quality credits (depending on maturity
assumption) under Advanced IRB
 Generally, PD for high-quality bank debt will be below 0.03% floor (so floor must be used)
 More realistic 10% LGD for Advanced IRB bank (rather than 45% supervisor-imposed LGD
for Foundation IRB banks) results in significant capital reductions
 Compare to 56 basis point floor for highest quality ABS
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Basel II – Corporate Capital Charges
Corporates – In a Nutshell
Basel I Basel II
Risk Standardised Standardised
100% FIRB est. risk weights*
Weight Option 1 Option 2
AA- or AA- or
20% 100% 14% - 24%
above above
External Rating
A 50% 100% A 24% - 28%
External Rating
BBB+ to
100% 100% BBB 38% - 68%
BB-
below
BB- 150% 100% BB+ to B- 100% - 197%
unrated 100% 100% below B- 226%
Unrated** NA
* Using inputs of rating agency values

for PD, LGD of 45%, supervisory
Winners Losers value for EAD and M of 2.5.
 Corporates rated  Corporates rated ** Internal PD estimate to be applied.

above BBB+ below BB-
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Corporates – Standardised Banks (¶¶ 66-68)
2 options, selected by national regulator to apply for all banks in jurisdiction:

 Option 1: Corporates risk weighted as set out in following chart (supervisory authority to
increase 100% risk weight for unrated corporates where warranted by higher default rates):
AAA to A+ to BBB+ Below

Rating Unrated
AA- A- to BB- BB-
Risk Weight 20% 50% 100% 150% 100%
 Option 2: At national discretion, all corporates risk weighted at 100% without regard to
external ratings
 SME Adjustment: 75% risk weight for unrated SME if exposure under €1 million and either
treated by bank as retail or guaranteed by individual
 Includes claims on insurance companies
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Corporates – IRB Banks (¶¶ 270-274)

 Formulas for corporate exposures same as for bank exposures, including floor for PD of 0.03%
 SME Adjustment for firms setting total annual sales (S) at €50 million or and €5 million or more:
Correlation (R) = 0.12 × (1 – EXP (-50 × PD)) / (1 – EXP (-50)) +

0.24 × [1 - (1 - EXP(-50 × PD))/(1 - EXP(-50))] – 0.04 × (1 – (S-5)/45)
 Subject to national discretion, supervisors may allow banks to substitute total assets for total
sales
 SME adjustment generates approx. 20% reduction in risk weights (depending upon original
creditworthiness)
 Effective floor of 14% risk weighting for foundation IRB banks due to minimum PD of 0.03%
representing a capital charge of 112 bps
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Basel II – Retail Capital Charges
Retail – In a Nutshell
Basel I Basel II
Risk
100% Standardised bank risk weights FIRB est. risk weights*
Weight
Generally 75% if conditions met Credit cards 70% - 110%**
Default From 150% to 50% depending on Other Retail 60% - 90%***
level of specific provisions
against exposure
 Internally * PD and LGD inputs provided by bank

determined PDs (¶ 331); PD floor at 0.03%
and LGDs under
** Using PD of 3% and LGD of 80% and
Foundation IRB
PD of 5% and LGD of 90%,
respectively
*** Using PD of 5% and LGDs of 40% and
60%, respectively
27
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Retail – Standardised Banks (¶¶ 69-71)

Generally
 75% risk weight if:
 Exposure to individual or small business
 Exposure takes form of revolving credit, line of credit, personal loan, lease, or small
business facility (mortgage loan excluded to extent otherwise covered (see below))
 Portfolio diversified (granular); Basel II accord suggests no aggregate exposure to any one
counterparty should exceed 0.2% of overall portfolio
 Maximum aggregate counterparty exposure €1 million or less
 Effective floor of 600 basis points
Past Due
 Unsecured portion of exposure past due for more than 90 days, net of specific provisions, risk
weighted as follows:
 150% when specific provisions less than 20% of outstanding amount of exposure
 100% when specific provisions 20% or more of outstanding amount of exposure
 100% when the specific provisions 50% or more of outstanding amount of exposure, with
supervisory discretion to reduce risk weight to 50% in such case
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Retail – IRB Banks (¶¶ 326-338)

 Formula for qualifying revolving retail exposure not in default:
Correlation (R) = 0.04
Capital requirement (K) = LGD × N[(1 - R)^-0.5 × G(PD) + (R / (1 - R))^0.5 × G (0.999)] – PD ×
LGD
 Formula for other retail exposure not in default:
Correlation (R) = 0.03 × (1 – EXP (-35 × PD)) / (1 – EXP (-35)) + 0.16 × [1 - (1 - EXP(-35
× PD))/(1 - EXP(-35))]
LGD
 When only drawn balances securitised, bank must hold required capital against unfunded
commitment
29
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Basel II – Real Estate Capital Charges
Real Estate – In a Nutshell
Basel I Basel II
Type of
Risk Weight Standardised bank risk weights FIRB est. risk weights
Exposure
Residential 50% Residential 35%* Residential
10% - 50%***
Commercial 100% Commercial 100%** Commercial
20% - 90%****
* Subject to conditions *** Using PD of 1% and LGD of 10%

** Reduced 50% risk weight possible, and PD of 2% and LGD of 25%
subject to conditions
**** Using PD range of 0.07% and 2.1%
and LGD of 35%
30
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Real Estate – Standardised Banks
Residential Real Estate (¶¶ 72-73)

 35% risk weight for exposures fully secured by mortgages on residential property occupied by
the borrower or rented
 Strict prudential criteria (including loan to value ratios) determined by national regulators
 Supervisors may require increased risk weight if data warrant
 Effective floor of 280 basis points
Commercial Real Estate (¶ 74)

 Generally 100% risk weight, given experience in numerous countries with troubled credits over
the past few decades
 However, 50% risk weight possible in certain markets if (among other conditions): (i) tranche not
greater than lower of 50% of market value and 60% of mortgage lending value, (ii) losses on
tranche do not exceed 0.3% in any year, and (iii) overall losses from commercial real estate in
relevant market do not exceed 0.5% in any year
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Real Estate – IRB Banks

 Residential Mortgages – Formula for exposure not in default (¶¶ 327-328):
Correlation (R) = 0.15
LGD
 High volatility commercial real estate (HVCRE) (¶¶ 280-284):
Supervisory Satisfactor
Strong Good Weak Default
Rating y
Risk Weight 95% 120% 140% 250% 0%
 At national discretion, banks may assign preferential risk weights of 70% to “strong” and
95% to “good” where maturity is less than 2.5 years or supervisor determines bank’s
underwriting criteria and other risk characteristics are substantially stronger
 Treated differently under CRD
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Basel II – Covered Bonds Capital Charges
Covered Bonds – In a Nutshell
Basel I (CRD) Basel II (CRD)

Type of EU Risk
Standardised bank risk weights FIRB est. risk weights***
Exposure Weight
UCITS Senior debt
10% 20%* 50%** 100% 150% PD of 0.03%
qualifying RW 4%
Covered bond
Exceptions* 20% RW 10% 20% 50% 100% PD of 0.15%
10%
* Italy, Portugal, Sweden, UK * Requires rating of AAA to AA-

*** LGD of 12.5% required in CRD with
** Requires rating of A+ to A- under PD floor of 0.03%. Using inputs PD as
Option 1 and rating of A+ to BBB- noted, LGD of 12.5%, supervisory
under Option 2 value for EAD and M of 2.5.
33
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Basel II – Specialised Lending Capital Charges
Specialised Lending – In a Nutshell
Basel I Basel II
Risk Weight Standardised bank risk weights (¶ 80) IRB bank risk weights (¶¶ 275-284)
All 100% All 100% Five Classes of Specialised Lending:

 Project finance
 Object finance
 Commodities finance
 Income-producing real estate
 High-volatility commercial real estate
Generally: For exposures other than HVCRE, banks

that do not meet requirements for estimation of PD will
map internal grades to five supervisory categories
(70% for strong, 90% for good, 115% for satisfactory,
250% for weak and 0% for default) (¶ 275)
At national discretion, supervisors may allow 50%
for “strong” and 70% for “good” if remaining maturity
less than 2.5 years or supervisor determines
underwriting or other risk characteristics are
substantially stronger (¶ 277)
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Basel II – Off Balance Sheet Items
Off Balance Sheet Items – Standardised Banks (¶¶ 82-89)

Off-balance sheet items converted into credit exposure equivalents using credit
conversion factor (CCF)
Commitments
 Original maturity of up to one year: 20% CCF
 Original maturity in excess of one year: 50% CCF
 Unconditionally cancelable: 0% CCF
Securities lending
 Lending of bank securities or posting as collateral (including repo and reverse repo
transactions): 100% CCF
Letters of Credit
 Short-term self-liquidating trade letters of credit: 20% CCF
Other commitments
 As specified in Basel I
Failed transactions
 As specified by national regulators
 Effect of failed transactions on off-balance sheet items subject to Basel/IOSCO review
35
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Basel II – Off Balance Sheet Items
Off Balance Sheet Items – IRB Banks (¶¶ 310-316)
Off-balance sheet items converted into exposure at default (EAD) input using credit conversion factor
(CCF) under either foundation approach to EAD or advanced approach to EAD:
Foundation approach to EAD

 Types of instruments and CCFs same as for standardised approach (¶¶ 82-89) except for
commitments, note issuance facilities (NIFs) and revolving underwriting facilities (RUFs)
 CCF of 75% applicable to commitments, NIFs and RUFs regardless of maturity
 CCF of 0% if commitment unconditionally cancelable
Advanced approach to EAD

 Banks allowed to use own estimates of CCF if allowed to use internal estimates for EAD (¶¶
474-478)
 But 100% CCF if required under foundation approach to EAD
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Basel II – Equity Capital Charges
Equity – In a Nutshell
Basel I Basel II†

Type of PD/LGD
Risk Weight Standardised bank risk weights Simple Model* Rating
Exposure Model**
Non-consol
100% Corporates 100%*
equity DaimlerChrysler 290% 92%*** A3/BBB
Banks 100%
Siemens 290% 81%*** Aa3/AA-
Securities
firms 100%
Company
Fresenius Med. Care 290% 264% Ba1/BB+
GE 290% 32%*** Aaa/AAA
Sony 290% 82%*** A1/A

†
For banking book
exposures. National Vivendi Universal 290% 195%*** Baa3/BBB-
supervisors may exempt
from IRB treatment for up to Bertlesmann 290% 120%*** Baa1/BBB+
ten years particular equity
exposures held at
publication date of Basel II ** Inputs: average rating
accord (¶ 267) agency PDs, LGD of 90%,
* CRD has preferential supervisory value for EAD
treatment vs. Basel II and M of 5.
Accord; supervisors may
increase to 150% for venture *** Under Basel II (¶ 353) a floor
capital and private equity risk weight of 200% applies
investments (¶ 80) to listed equities
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Basel II – Equity Capital Charges
IRB Banks – Three Approaches

Simple risk method (¶¶ 344-345)
 CRD: 190% risk weight for diversified private equity exposures (not in Basel II)
 CRD: 290% risk weight for publicly traded exposures (300% in Basel II)
 CRD: 370% risk weight for all other holdings (400% in Basel II)
Internal models method (¶¶ 346-349)
 Taken from VaR models as 12.5 times difference between
 99% percentile one-tail quarterly return and
 Risk free rate over long-term sample period
 Floor: capital charge under simple risk model but using 200% (traded) and 300% (not traded)
PD/LGD method under CRD (¶¶ 350-361)
 Generally, use normal corporate exposure formulas if possible (results in risk weights substantially
below 200% and 300% floor in Basel II)
 If bank does not have sufficient information to use definition of default, then apply scaling
factor of 1.5 to risk weights
 Unfunded credit protection on equity exposure recognised, subject to LGD of 90%, with
reduced LGD of 65% for private equity exposures
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Basel II – Non-Performing Loan Capital Charges
Non-Performing Loans (NPLs) – In a Nutshell
Basel I Basel II/CRD
No uniform rules: Standardised bank risk weights (¶¶ 75-78) IRB bank risk weights
 In Europe – combination
Generally: Unsecured portion of exposure past due Generally: capital requirement for defaulted exposure
of general and specific
for more than 90 days, net of specific provisions, risk is equal to greater of zero and difference between LGD
provisions
weighted as follows: (described in para. 468) and bank’s best estimate of
 In US five-tier ranking expected loss (¶ 272)
 150% when specific provisions less than 20%
system derives capital
of outstanding amount of exposure Under IRB approach, for asset classes other than
securitisation, bank must compare (i) total amount of
 100% when specific provisions 20% or more of
eligible provisions with (ii) total expected losses and
outstanding amount of exposure
deduct excess (if any) of expected losses over
 100% when specific provisions 50% or more of provisions (¶ 43, ¶¶ 380-383)
outstanding amount of exposure, with
For securitisation exposures or the PD/LGD approach
supervisory discretion to reduce risk weight to
for equity exposures, bank must first deduct EL amounts
50% in such case
under paras. 563 and 386, respectively (¶ 43)
Residential Mortgages: risk weighted at 100% net
of specific provisions; at national discretion risk
weight reduced to 50% of specific provisions 20% or
greater
Commercial Mortgages: unexpected loss risk-
weighted at 100%
39
Source: Text
Non-performing loans – Generally
Essentials:
 Non-performing loan under Basel II is any loan that is past due for more than 90 days, but
subject to national variation
 For purposes of defining secured portion of non-performing loan, eligible collateral and
guarantees will be recognised as under CRM rules for performing loans
 Capital charges depend on level of specific provisions held against loan
40
Non-performing loans – Standardised Approach
Unsecured non-performing loan:

 Unsecured portion of non performing loan will be risk-weighted as follows:
 150% when specific provisions less than 20% of outstanding amount of exposure
 100% when specific provisions 20% or more of outstanding amount of exposure
 100% when specific provisions 50% or more of outstanding amount of exposure, with
supervisory discretion to reduce risk weight to 50% in such case
Secured non-performing loan:
 Qualifying residential mortgage loans risk weighted at 100%, net of specific provisions. If
such loans are past due but specific provisions are no less than 20% of their outstanding
amount, the risk weight applicable to the remainder of the loan can be reduced to 50% at
national discretion
 Commercial mortgages: unexpected loss risk weighted at 100%
 Non-performing loans fully secured by forms of collateral not recognized under Basel II (eligible
financial collateral) risk weighted at 100% when provisions reach 15% of outstanding amount of
loan
41
Non-performing loans – IRB Approach
General Rules:
 Capital charges to cover unexpected losses
 Bank must cover expected losses with specific provisions
Consequences:
 Fixed LGD at 45% for non-retail assets and senior exposures may result in risk weights as
follows:
 565% when no specific provisions of outstanding amount of exposures
 400% when specific provisions 20% of outstanding amount of exposure
 0% when the specific provisions 50% or more of outstanding amount of exposure
42
Non-performing loans – sample capital calculation (€100 million NPL)
Specific Provisions 0% 30% >50% 80%

Net exposure 100 70 <50 20
Capital Charges
Basel I 8.0 5.6 3.2 1.6
Standardised Approach 12.0 5.6 1.6 0.8
IRB Approach 45.0 15.0 0.0 0.0
Advanced IRB Approach 30.0 0.0 0.0 0.0
Risk Weights
Basel I 100% 100% 100% 100%
Standardised Approach 150% 100% 50% 50%
IRB Approach 565% 270% 0% 0%
Advanced IRB Approach 380% 0% 0% 0%
Assumptions:
 Supervisory discretion allows use of 50% risk weight if exposure has specific provision of 50% or better
 LGD in Advanced IRB Approach is 30%
 IRB Approach and Advanced IRB Approach are approximated
43
Non-performing loans – Originator´s point of view and market outlook
Motivations to sell non-performing loan portfolios:

 Reduce capital supporting non-performing loans
 Reduce negative carry by eliminating financing needs
 Shift capital and resources into more profitable businesses
 Optimize bank’s balance sheet
 Improve bank’s credit ratings
 Reduce operating costs due to smaller work-out departments
Market outlook
 Basel II will motivate banks to sell NPLs
 German NPL market estimated between €160 billion and €300 billion (Boersenzeitung
18.2.2005)
 German NPL market development to increase to estimated €20 billion this year and possible
average of €15 billion per year after 2007 (Boersenzeitung 18.2.2005)
 No capital charges required if investors not banks
44
Basel II – Credit Risk Mitigation
Credit Risk Mitigation (CRM) – In a Nutshell
Basel I Basel II
Type of
Risk Weight* Standardised banks IRB banks
Exposure
OECD
0% Simple approach: Risk weight of CRM is Generally: CRM reduces PD or LGD inputs
sovereign
substituted for risk weight of unsupported exposure
OECD bank 20% Comprehensive approach: Adjust value of both
Non-OECD amount of exposure and value of CRM with either
20%
bank** supervisory or own-estimate “haircuts”; adjust for
maturity and currency mismatches
* Same as simple
approach under Basel II
for standardised banks
†
Subject to considerable change due to
(i.e., substitution) Basel/IOSCO review, including introduction of
“double default” recognition for certain exposures
** Maturity of < one year rather than substitution approach
45
Source: Text
Credit Risk Mitigation – General Rules (¶¶ 109-210)
Determine capital as provided on following page, except

Protection Buyer determine capital pursuant to securitisation rules (following) if
credit risk protection tranched (e.g., purchased derivatives)
Protection Seller Treat as cash position in underlying
 First to default and second to default protection

(¶¶ 207-210)
Specific Adjustments  Proportional cover (¶ 190(c), ¶ 198))
 Maturity and currency mismatches: size of
haircut depends on type of instrument, type of
transaction and frequency of mark-to-market and
remargining (¶ 135)
46
Credit Risk Mitigation – Capital Calculation Method

Simple Approach (¶ 129, ¶¶182-185)
 Risk weight of CRM substituted for risk weight of unsupported exposure (¶ 129)
Standardised Banks  Subject to floor of 20%, with exceptions, e.g., core market participant floor is 0%,
subject to certain conditions (¶ 183)
Comprehensive Approach (¶¶ 130-138)
 Supervisory or own-estimate haircuts adjust both amount of exposure and value
of collateral received (¶ 130)
 Further adjustments for maturity mismatches (square root of time formula) and
currency mismatches (¶ 135)
Guarantees and credit derivatives recognised; only limited double-default
recognition proposed under Basel/IOSCO review (¶¶ 140-142, ¶¶189-193)
VaR models permitted subject to supervisory approval (¶ 138, ¶¶ 178-181)
On-balance sheet netting recognised (¶ 139, ¶ 188)
IRB Banks Generally

 Collateral reduces PD or LGD input (reducing required capital) (¶¶ 289-307)
Guarantees and credit derivatives recognised; only limited double-default
recognition proposed under Basel/IOSCO review (¶ 301)
VaR models permitted subject to supervisory approval (¶ 292)
On-balance sheet netting recognised (¶ 292)
47
Credit Risk Mitigation - Eligible Financial Collateral

 Cash and gold
 Rated debt securities (sovereign BB- or higher; other BBB- or higher)
Eligible Collateral  Senior, unrated debt securities issued by bank if listed on recognised
exchange and all other bank issues are BBB- or higher
(¶¶ 145-146)
 Equities included in main index or listed on recognised exchange
 UCITS/mutual funds where price quoted daily and UCITS/fund only invests
in above instruments
 For IRB banks only: receivables, real estate and other collateral meeting
minimum requirements (¶ 289)
 All items recognised as collateral in banking book can also be recognised in
trading book
No correlation Collateral must not have material positive correlation with underlying exposure
(¶ 124)
 First-to-default: recognised if bank obtains protection for entire basket,

credit event triggers contract, and notional of underlying less than contract
First-to-Default (¶¶ 207-208); regulatory capital relief for asset with lowest risk-weight in the
Second-to-Default basket
 Second-to-default: recognised if bank obtains first-to-default protection as
above or if one asset already defaulted (¶¶ 209-210)
48
Credit Risk Mitigation - Other Criteria
Recognition of credit derivatives (¶¶ 191-194)
 Legally binding documentation; direct claim on provider; irrevocable and unconditional
 Mandatory credit events not determined solely by protection provider: (a) failure to pay,
(b) insolvency and (c) Restructuring (recognition up to 60% of underlying if no
restructuring)
 If asset mismatch, underlying/reference obligation must be pari passu and protection
must contain cross-default/cross-acceleration
 Cash settlement permitted if robust valuation process
 If protection purchaser’s right to transfer underlying subject to obligor consent, may not
be unreasonably withheld
Eligible protection providers (¶ 195)
 Sovereigns, public sector entities, and banks and securities firms with lower risk
weighting than underlying exposure (not SPEs)
Counterparty risk charges for OTC derivatives (¶¶ 186-187)
 Counterparty credit risk charge = [(RC + add-on) – CA] x r x 8% where: RC=replacement
cost; add-on= as determined under Basel I; C A=volatility adjusted collateral amount;
r=risk weight of counterparty
 Being changed to model-based approach under Basel/IOSCO review
49
Source: Text
Basel II – Securitisation Capital Charges
Securitisation – In a Nutshell
Basel I Basel II
Type of
Risk Weight Standardised banks IRB banks
Exposure
Generally 100% Risk weights based on rating of position. If exposure Hierarchy of approach:
unrated, then deduct from capital except in case of:
 If exposure rated must determine risk weight
First loss Deduct  Most senior exposure (look-through to average based on ratings based approach (RBA)
Unfunded < risk weight of pool)
 If unrated exposure to ABCP conduit may use
one year 0%  Second loss position or better (look-through to internal assessments approach (IAA) if
higher of 100% and highest risk weight of pool) conditions met
 Liquidity facilities (credit conversion factors  If unrated exposure may use supervisory
depending on type and length of liquidity formula approach (SFA) if can determine
commitment) inputs (including using top down methodology)
 If unrated exposure and RBA, IAA and SFA
unavailable, may use exceptional “look
through” approach with regulator consent on
temporary basis for liquidity facilities
 Otherwise, must deduct unrated exposure from
capital
50
Source: Text
Securitisation – Standardised Banks – Ratings Based Approach
Short Term Ratings Long Term Ratings
Standardised bank risk weights (¶ 567) Standardised bank risk weights (¶ 567)
AA- or
A-1/P-1 20% 20%
above
External Rating
A-2/P-2 50% A 50%
External Rating
A-3/P-3 100% BBB 100%
BB+ to
All other 350%*
Deduct BB-
ratings/
unrated B+ or
below Deduct
unrated Deduct
* Originating banks must deduct BB+ to

BB- exposures (¶ 569)
51
Source: Text
Securitisation – Standardised Banks

Except as provided below, unrated securitisation exposures must be deducted (¶ 567)
Most senior exposures (¶¶ 572-573)
 If the most senior tranche is unrated, the bank that holds or guarantees that position
may “look through” to the underlying pool to determine the risk weight (and may
assign a risk weight equal to average of risk weight assigned to exposures in
underlying pool), provided that the composition of the pool is known at all times
Second loss positions or better (¶¶ 574-575)
 Qualifying exposures provided by sponsor banks in ABCP programs that are in
second loss position or better may apply a risk weight equal to the greater of (x) 100%
and (y) the highest risk weight assigned to any exposure in underlying pool, but only
if:
 The first loss position provides significant credit protection
 The associated credit risk is investment grade or better
 The bank holding the exposure does not hold the first loss position
Eligible liquidity facilities (¶ 576)
 Banks may apply risk weight to eligible liquidity facilities equal to highest risk weight
assigned to any exposure in underlying pool
52
Source: Text
Liquidity facilities (¶¶ 579-580)
Generally
 20% credit conversion factor (CCF) for eligible liquidity commitments with an original
maturity of one year or less
 50% CCF for eligible liquidity commitments of more than one year
 100% CCF for all other liquidity commitments, including rated commitments
Increase from 0% under Basel I
 Regulators believe liquidity absorbs more than just liquidity risks
Credit conversion factor of 0% theoretically possible if:
 Commitment qualifies as “eligible liquidity”
 Commitment can only be drawn if general market disruption (i.e., where more than
one SPE across different transactions is unable to roll over maturing commercial
paper – i.e., not as result of impairment in credit quality of specific SPE or its pool)
 Commitment must be secured by underlying assets and rank pari passu with conduit’s
securities
53
Source: Text
“Eligible Liquidity” (¶ 578)

 Documentation must identify and limit circumstances of draw, and amounts drawn
must be limited to amount likely to be repaid from underlying assets and seller-
provided credit enhancement
 No incurred losses should be covered and draw should not be automatic
 Asset quality test should not cover defaulted assets as defined in paragraphs 452-459
(including receivables more than 90 days past due unless extended up to 180 days by
national regulators); if funding based on rating of underlying asset, it must be rated at
least investment grade at time of draw
 Facility cannot be drawn after all applicable credit enhancement to which liquidity
facility has access has been exhausted
 Repayment of draws must not be subordinated to interests of any conduit security
holder
54
Source: Text

Overlapping Exposures (¶ 581)
For example, if conduit sponsor provides programme-wide liquidity and credit
enhancement to ABCP conduit:
 If funding one exposure precludes funding the other exposure, sponsor need not hold
capital against both exposures
 Instead, for overlapping portion sponsor should hold capital against exposure with
highest credit conversion factor
Query
 How to allocate partial credit enhancement
 How to allocate programme-wide credit enhancement
Eligible servicer advances (¶ 582)

 Servicers may contractually agree to advance cash to insure uninterrupted payments
to investors if full reimbursement right is senior to other claims
 At national discretion, CCF of 0% for facility cancellable without prior notice
55
Source: Text
Securitisation – IRB Banks
Options
 IRB bank must calculate capital on basis of:
 external ratings pursuant to ratings based approach (RBA)
 inputs into supervisory formula (SF) approach
 internal assessments approach (IAA)
 Cap: If IRB would require more capital for securitisation exposure than had the position not
been securitised, bank may use IRB capital requirement for underlying exposures (¶ 610)
Hierarchy (¶ 609)
 IRB bank must use ratings based approach (RBA) to calculate capital if external rating or
inferred rating available
 Where RBA not available, bank may use SF or IAA if available
 Where neither RBA nor SF or IAA are available, bank may use look-through approach (see
below) in paragraph 639
 Otherwise, position must be deducted
56
Source: Text
Securitisation – IRB Banks – Ratings Based Approach
Short Term Ratings Long Term Ratings
IRB bank ratings-based risk weights (¶¶ 616) IRB bank ratings-based risk weights (¶¶ 615)
Most Most
Base case Non-granular Base case Non-granular
senior senior
A-1/P-1 7% 12% 20% AAA 7% 12% 20%
External Rating
A-2/P-2 12% 20% 35% AA 8% 15% 25%
A-3/P-3 60% 75% 75% A+ 10% 18% 35%
All other A 12% 20% 35%

ratings/ Deduct Deduct Deduct
External Rating
unrated A- 20% 35% 35%
BBB+ 35% 50% 50%
BBB 60% 75% 75%
BBB- 100% 100% 100%
BB+ 250% 250% 250%
BB 425% 425% 425%
BB- 650% 650% 650%

<BB- or
unrated Deduct Deduct Deduct
57
Source: Text

Internal Assessments Approach (¶¶ 619-622)
IRB bank may use IAA if conditions satisfied
 Only available for exposures to ABCP programmes
 Internal assessments mapped to equivalent external ratings and exposures assigned
resulting risk weights
 Supervisor may suspend bank’s use of IAA until deficiencies (if any) are corrected
Conditions
 ABCP issued by conduit must be externally rated
 Internal assessment must be based on ratings criteria for each asset type and be
equivalent of investment grade when exposure is funded
 Bank’s supervisors must be satisfied that internal ratings meet required criteria in
paragraphs 90-108 and with relevant external ratings criteria
 Bank must show that internal criteria matches external criteria
58
Source: Text
Conditions (cont’d)
 Supervisor may, if warranted, disallow any seller provided recourse, guarantees or excess
spread or any other first loss enhancement
 Internal assessment must identify gradations of risk that can be mapped to external ratings
gradations
 Internal assessment process, and particularly stress factors, must be at least as conservative as
publicly available ratings criteria from rating agencies rating ABCP programme:
 Bank must choose most conservative of two or more external criteria if two or more criteria
apply
 Bank must not choose only ratings agencies with less restrictive methodologies to rate
ABCP programme and must keep up with methodology changes
 Bank cannot use a non-public ratings methodology but may consider more conservative
non-publicly available methodology
 For new or unique transactions, bank may discuss applying IAA with supervisor
59
Source: Text
Conditions (cont’d)
 Internal and external auditors, a rating agency, or bank’s internal credit review or risk
management function must perform regular reviews of internal assessment process; if internal
reviews are used, they must be independent of ABCP business line
 Bank must track and adjust internal processes over time
 ABCP programme must have credit and investment guidelines (which should cover issues
specified by supervisor)
 Credit analysis of seller’s risk profile must be performed
 ABCP programme must have minimum asset eligibility criteria that exclude defaulted assets,
limit concentrations, limit asset tenor, etc.
 ABCP programme should have collections processes established that consider operational
capability and credit quality of servicer, lockbox arrangements, etc.
 All sources of risk must be considered (including credit and dilution)
 Structural features must be included such as wind down events
60
Source: Text

Supervisory formula approach (¶¶ 623-636)
Capital charge determined under supervisory formula (see following page) on basis of
five inputs (with 56 basis point floor):
 Regulatory capital of exposure if held on balance sheet (K IRB)
 Degree of credit enhancement supporting exposure (L)
 Exposure’s thickness (T)
 Effective number of exposures in the securitised pool (N)
 Pool’s exposure-weighted average loss given default (LGD)
Definition of KIRB
 KIRB is ratio (expressed as a decimal) of
 the IRB capital requirement for the underlying exposures in the pool to
 the notional amount of such exposures
 For structures involving SPE, all SPE assets must be included in pool, including
residual interests (such as a cash collateral account)
 Reserves against assets in pool do not reduce notional amount of the pool in
determining KIRB, but can count as credit enhancement
61
Source: Text

Supervisory Formula (¶¶ 624-626):
IRB Capital charge = greater of (a) 0.0056 and (b) (S [L+T] – S [L])
S[L] = L if L<= KIRB, else,
S[L]= KIRB +K[L] –K[KIRB] +(d. KIRB /ώ )(1- exp(ώ *(KIRB –
L)/ KIRB))
Where
h=(1- KIRB /LGD)N
c= KIRB /(1-h)
v =((LGD- KIRB) KIRB +0.25(1-LGD) KIRB )/N
f=((v + KIRB 2 )/(1-h) – c 2 ) + (((1- KIRB) KIRB – v )/(1-h) τ )
g=((1-c)c)/f -1
a=gc
b=g(1-c)
d=1-(1-h)(1-Beta[KIRB, a,b])
K[L]=(1-h)((1-Beta[L,a,b]L+ Beta[L,a+1,b]c)
Beta [L,a,b] refers to the cumulative beta distribution with
parameters a and b evaluated at L,
τ =1000 and ώ = 20
62
Source: Text

Liquidity facilities (¶¶ 637-639)
Generally
 “Eligible” liquidity facilities only drawn in event of general market disruption (as defined in ¶
580) have a 20% CCF
 Otherwise, all liquidity facilities have 100% CCF; 100% CCF permits IRB banks to provide
multi-year liquidity or “structured” liquidity without additional capital requirements
Determination of capital
 If facility is externally rated, bank may rely on rating provided it uses 100% CCF
 If facility is unrated, bank may use IAA if qualifying
 If facility is unrated and IAA unavailable, bank must determine K IRB either using “bottom-up”
approach or “top-down” approach and apply SF
“Look-through” procedure
 If not practical to use “bottom-up” or “top-down”, bank may, on an exceptional basis and
subject to supervisory approval, temporarily apply highest risk weight of pool under
standardised approach to individual exposures covered by eligible liquidity facility
 In such a case, the bank must use 50% CCF for commitments of one year or less and
100% for commitments in excess of a year, or 20% CCF for market disruption liquidity
63
Source: Text

Top-Down Approach (¶¶ 362-373)
 For use in determining KIRB in SF
 Generally
 Top-down approach available provided bank’s programme complies with criteria for
eligible receivables and minimum operational requirements
 Intended mainly for asset-backed securitisation exposures, but may also be used for
appropriate on-balance sheet exposures
Eligible Corporate Receivables (¶¶ 241-243)
 Eligible corporate receivables must satisfy following conditions for application of top-down
approach:
 Bank has not directly or indirectly originated receivables (and has purchased them
from unrelated third parties)
 Receivables generated on arms length basis (and not subject to inter-company
contra accounts)
 Purchasing bank must have claim on all proceeds from pool or a ratable interest
 National supervisors to develop concentration limits
 Recourse to seller does not automatically disqualify transaction as long as cash flows from
assets are primary source of repayment (plus certain other requirements)
64
Source: Text
Inferred Ratings (¶¶ 617-618)

 When following conditions are met, bank must attribute inferred rating to unrated
exposure:
 Reference rated exposure must be subordinate in all respects to unrated exposure
 Credit enhancements must be taken into account in determining subordination (for
example, if reference position benefits from third party guarantee but unrated
position does not, then latter may not be assigned inferred rating)
 Maturity of reference position must be equal to or longer than that of unrated
position
 Inferred rating must be updated continuously to reflect changes in external rating of
reference position
 External rating must satisfy general requirements for recognition of external ratings
in securitisation transactions
65
Source: Text
Basel II – Early Amortisation Structures
Securitisation – Early Amortisation Provisions
Originating banks are required to hold capital against investors’ interests in a securitisation
when
 It sells assets into a structure containing an early amortisation feature and
 The exposures sold are of a revolving nature
Banks are not required to apply the early amortisation rules to:
 Replenishment structures where the underlying exposures do not revolve and the early
amortisation ends the bank’s ability to add new exposures
 Transactions of revolving assets containing early amortisation features that mimic term
structures (i.e., where the risk does not return to the originating bank)
 Structures securitising credit lines where the investors remain liable to fund future draws by
borrowers after amortisation events
 The early amortisation clause is triggered solely by events unrelated to the performance of the
pool or the originator
66
Applicable capital charge

 equals (1) the notional amount of the investors’ interest times (2) the applicable credit
conversion factor times (3) the risk weight for the underlying credits
 but capitalised assets (such as future margin income) are treated separately and will
typically be deducted from capital
Capped at the greater of:
 the capital required for retained securitisation exposures
 the capital required had the exposures not been securitised
Applicable credit conversion factor based on whether
 the amortisation is “controlled” or “non-controlled”
 the securitised exposures are (i) uncommitted retail credit lines that are unconditionally
cancellable or (ii) any other type of exposure
67
A “controlled” amortisation must meet the following conditions:

 The originator has in place a capital/liquidity plan to ensure it has sufficient capital and
liquidity if early amortisation occurs
 Throughout the transaction, including the amortisation period, there is a pro rata sharing
of interest, principal, expenses, losses and recoveries based on the balances of
receivables outstanding at the beginning of each month
 The amortisation period fixed by the bank is sufficient for 90% of the total debt
outstanding at the beginning of the period to have been repaid or to have been
recognised as in default
 The pace of repayment is not any more rapid than would be allowed under straight-line
amortisation over the period fixed as described above
68
Credit conversion factors (CCF)

 For structures with controlled amortisation
 0% to 40% for uncommitted retail lines (see next page)
 90% for committed retail lines
 90% for all non-retail lines (whether committed or uncommitted)
• For structures with non-controlled early amortisation
 0% to 100% for uncommitted retail lines (see next page)
 100% for committed retail lines
 100% for all non-retail lines (whether committed or uncommitted)
For uncommitted retail credits
 Calculate two points:
 The point at which the bank is required to trap excess spread (or 4.5% above the early
amortisation trigger if no trapping)
 The three month average excess spread for the transactions
 Divide the excess spread level by the trapping point and look up the CCF for the transaction on
the following page
69
3 month average excess CCF for Uncommitted CCF for Uncommitted

spread as % of trapping Retail Exposures in Retail Exposures in Non-
point Controlled Structures Controlled Structures
133.33% or more 0% 0%
Less than 133.33% to 100% 1% 5%
Less than 100% to 75% 2% 15%
Less than 75% to 50% 10% 50%
Less than 50% to 25% 20% 100%
Less than 25% 40% 100%
70
Basel II – Trading Book Capital Charges
Trading Book – In a Nutshell*
Basel I (1996 Market Risk Amendment) Basel II (MRA; Accord ¶¶ 864-718)
Minimum capital requirement: Essentially unchanged, except for revisions to:

 Credit risk requirements under regulatory capital rules,  Definition of trading book: “positions in financial
excluding debt and equity securities in trading book and instruments and commodities held either with trading
all positions in commodities, but including credit intent or in order to hedge other elements of the trading
counterparty risk in trading book or banking book, plus book”
 Capital charges for specific risk and general market risk  Basic requirements for trading book treatment: clearly
under either standardised measurement method or documented trading strategy; positions actively
internal models method (or combination thereof) monitored and managed on trading desk; position limits
set and monitored; positions marked to market at least
daily; positions reported to senior management
 Capital charges for specific risks in connection with
* Paragraph references in materials below on trading interest rate risk (see below)
book are to 1996 Market Risk Amendment (MRA)
 Specific risk capital charge offsets for positions hedged
unless otherwise noted
by credit derivatives (see below)
 New counterparty credit risk charges for OTC
derivatives, repo-style and other transactions booked in
trading book, and adjusted add-on factors for single
name credit derivatives (see below)
Basel/IOSCO review will change trading book

treatment significantly
71
Source: Text
Capital Requirement
Definition of Capital (MRA Intro., II.1 – I.2)
 At discretion of national regulators banks may employ third tier of capital for sole purpose of meeting
proportion of capital requirements for market risks
 Tier 3 capital limited to 250% of bank’s tier 1 capital required to support market risks; tier 2 capital
may be substituted for tier 3 capital up to same 250% limit subject to overall limits for tier 2 capital in
Basel II Accord
 For subordinated debt to be eligible as tier 3 capital it must be available to absorb losses in event if
insolvency and must at minimum:
 Be unsecured, subordinated and fully paid up
 Have original maturity of at least two years
 Not be repayable prior to maturity date unless bank’s supervisor agrees
 Be subject to lock-in clause stipulating that neither interest nor principal may be paid at maturity
if payment would cause bank to fall below minimum capital requirements
Calculation of Capital (MRA Intro., II.3 – I.4)
 Bank must first calculate capital for credit risk, and only afterwards calculate market risk requirement
Capital requirement to be met on continuous basis – at close each business day (MRA Intro., I.14)
72
Source: Text
Standardised Measurement Method – Interest rate risk
Specific risk (MRA Part A.1.I; Accord ¶ 710)
 Specific risk charge:
 Government:
AAA to AA- 0.00%
A+ to BBB- 0.25% (residual term to final maturity 6 months or less)
1.00% (residual term to final maturity between 6 and 24 months)
1.60% (residual term to final maturity exceeding 6 months)
Other rating: 8.00%
 Qualifying: 0.25% (residual term to final maturity 6 months or less)
1.00% (residual term to final maturity between 6 and 24 months)
1.60% (residual term to final maturity exceeding 6 months)
 Other: 8.00%
 Offsetting restricted to matched positions in identical issue (including positions in derivatives); no
offsetting if issuer same but not same issue
 “Government” category includes all forms of government paper
 “Qualifying” category includes securities rated investment grade by at least two recognised rating
agencies or (subject to supervisory approval) unrated but either of comparable investment quality
(standardised banks) or rated equivalent by bank’s internal systems and exchange listed (IRB banks)
(Accord ¶ 712)
 National regulatory may impose higher specific risk charge on “other” category and/or disallow
offsetting
73
Source: Text
Standardised Measurement Method – Interest rate risk (cont’d)
General market risk (MRA Part A.1.II)
 Generally
 Two methods: maturity method and duration method
 Capital charge is sum of four components: net short or long position; small proportion of
matched positions in each time band (vertical disallowance); larger proportion of matched
positions across different time bands (horizontal disallowance); net charge for positions in
options
 Maturity method
 Opposite positions of same amount in same issue may be omitted from framework
 Positions weighted by prescribed price sensitivity factor
 Partial offset (10% capital charge) for weighted longs and shorts in each time band
 Two rounds of horizontal partial offsetting between time bands pursuant to prescribed scale
 Duration method
 Calculate price sensitivity on basis of prescribed interest rate change depending on maturity
 Slot resulting sensitivity measures into duration-based ladder within time bands
 Subject long and short positions to 5% vertical disallowance
 Carry forward net positions for horizontal offsetting as above
74
Source: Text
Interest rate derivatives (MRA Part A.1.III)
 Convert derivatives into positions in relevant underlying subject to specific and general market risk
charges as above
 Futures: treated as combination of long and short position in notional government security
 Swaps: treated as two notional positions in government securities with relevant maturities
 No specific risk charge for most interest rate derivatives
 General market risk charge generally same as for cash positions, subject to exemption for very
closely matched positions in identical instruments
Counterparty credit risk charge add-on factors for single name credit derivative (Accord ¶ 707)
 If reference asset is qualifying: 5% for protection buyer and 5% for protection seller
 If reference asset is not qualifying: 10% for protection buyer and 10% for protection seller
75
Source: Text
Offsetting for interest rate derivatives (MRA Part A.1.III)

 Banks may exclude long and short positions (both actual and notional) in identical instruments with
exactly the same issuer, coupon, currency and maturity, and may fully offset a matched position in a
future or forward and its underlying
 If choice of underlying deliverable instruments (e.g., cheapest-to-deliver), offset only permitted if
future or forward move in close alignment
 Offset may be allowed for opposite positions in same category of instruments if same underlying,
same nominal value and same currency – e.g., futures (identical products maturing within 7 days of
each other); swaps and forward rate agreements (identical reference rate and coupon within 15
basis points); limits on next interest fixing date
 No offsetting for positions in different currencies
But modified by Accord (see next page)
76
Source: Text
Specific risk capital charges for positions hedged by credit derivatives (Accord ¶¶ 713-718)
 No specific risk capital charge for either side of the position if values of full legs always move in the
opposite direction and generally to the same extent (e.g., identical instruments; long cash position
hedged by total rate of return swap with exact match between reference obligation and underlying)
 80% specific offset recognised when value of two legs always moves in opposite direction but not
broadly to same extent (e.g., long cash position hedged by credit default swap or credit-linked note
with exact match between reference obligation and underlying); to extent that transaction transfers
risk, 80% risk offset for side with higher capital charge and zero specific risk requirement on other
side
 Partial allowance where value of two legs usually moves in opposite direction (e.g., asset mismatch
between reference and underlying)
 Otherwise, specific risk capital charge for both sides of transaction
77
Source: Text
Standardised Measurement Method – Equity position risk
Specific risk and general market risk (MRA Part A.2.I)
 Specific risk charge
 Defined as bank’s gross equity position, calculated on national market-by-market basis
 8% unless portfolio both liquidity and well-diversified, in which case 4%
 General market risk charge
 Defined as difference between sum of longs and sum of shorts, also calculated on national
market-by-market basis
 8%
Equity derivatives (MRA Part A.2.II)
 Convert derivatives into positions in relevant underlying
 Matched positions may be fully offset
 Index risk: Further capital charge of 2% against net long or short position in index contract
comprising diversified portfolio of equities to cover factors such as execution risk
 Arbitrage: Additional 2% capital charge in qualifying futures-related arbitrage strategies may be
applied only to one index with opposite position exempt from capital charge
78
Source: Text
Standardised Measurement Method – Foreign exchange risk
Two processes (MRA Part A.3)
 Measure exposure in single currency position
 Measure risks inherent in mix of long and short positions in different currencies
Measuring positions in single currency (MRA Part A.3.I)
 Measured by summing: net spot position (including interest earned but not received, expenses
accrued, and expenses not yet accrued but certain); net forward position; guaranties certain to be
called and likely to be irrevocable; net future income/expenses not yet accrued but already fully
hedged (at bank discretion); net delta-based equivalent of total book of foreign currency options
 Positions taken to hedge capital ratio may be excluded if “structural” (non-dealing) nature, applied
consistency, does no more than protect bank capital ratio
Measuring foreign exchange risk (MRA Part A.3.II)
 Two alternatives:
 “shorthand” method treating all currencies equally – capital charge is 8% times overall net
open position determined by converting nominal amount (or net present value) of net position
in each currency into reporting currency
 internal models approach (see below)
79
Source: Text
Standardised Measurement Method – Commodities risk
Generally (MRA Part A.4)
 Defined as physical product which is or can be traded on a secondary market
 More complex and volatile, and less liquid
 Variety of additional risks, including basis risk (risk that relationship between prices of similar
commodities varies over time); interest rate risk (risk of cost of carry); forward gap risk (risk that
forward price may change other than due to interest rate changes)
 Three options: models (see below); measurement system; simplified approach
Measurement system (maturity ladder) approach (MRA Part A.4.II)
 Express commodity position in standard unit of measurement (barrel, etc.)
 Convert net position at current spot rates into national currency
 Assess capital charge against matched long and short positions in specified time bands and
specified spread rates
 Residual net positions in nearer time banks may be carried forward to offset exposures in later
time bands, subject to surcharge equal to 0.6% of net position carried forward
 15% capital charge against resulting long or short position
Simplified approach (MRA Part A.4.III)
 Same capital charge for directional risk as under measurement approach
 Additional capital charge of 3% of gross positions in each commodity for basis risk, interest rate
risk and forward gap risk
80
Source: Text
Standardised Measurement Method – Options
Generally (MRA Part A.5)
 Banks with purchased options only permitted to use simplified approach
 Otherwise, use either one of the intermediate approaches (see below) or internal model (see below)
Simplified approach (MRA Part A.5.I)
 Long cash and long put, or short cash and long call: Capital charge is market value of underlying
multiplied by sum of specific and general market risk charges for underlying less amount option is in
money (if any) bounded by zero
 Long call or long put: Capital charge is lesser of (a) market value of underlying multiplied by sum of
specific and general market risk charges for underlying and (b) market value of option
Delta-plus (intermediate) approach (MRA Part A.5.II)
 Options reported as position equal to market value of underlying multiplied by delta
 Delta-weighted capital charge: Determined pursuant to Parts A.1 through A.4 depending on whether
option underlying is debt security or interest rate instrument (Part A.1), equity (Part A.2), foreign
exchange and gold (Part A.3) or commodities (Part A.4)
 Additional capital charges for gamma (measuring rate of change of delta) and vega (measuring
sensitivity of value of option to change in volatility)
Scenario (intermediate) approach (MRA Part A.5.II) (for more sophisticated banks)
 Capital charge determined by calculating changes in option value at various points along “grid” of
ranges of changes in option portfolio’s risk factors
81
Source: Text
Internal models method (MRA Part B)
Generally (MRA Part B.1)
 Conditional upon explicit approval of supervisor
Conditions to use of internal model (MRA Parts B.2 – B.7)
 Qualitative standards: independent risk control unit; integration with day-to-day risk management
of bank; trading limits; compliance function; stress-testing; back-testing; external validation;
independent review
 Quantitative standards: value-at-risk calculated daily (to 99 th percentile, one-tailed confidence
interval; with instantaneous price shock equivalent to 10 day movement in prices); update data
sets no less frequently than every three months; no particular type of model prescribed (but must
accurately capture option risks); discretion to recognise empirical correlations within broad risk
categories; daily calculation of capital requirement; multiplication factor based on supervisor
judgment of quality of bank’s risk management system
 Market risk factors: risk measurement system that models yield curve (interest rate risk), foreign
exchange exposures (foreign exchange risk), market movements in equities (equity risk),
convenience yield (commodities risk)
82
Source: Text
Chapter 3
Basel II – First Pillar
Operational Risk Capital Charges
Basel II – Operational Risk Charges
Defined as risk of loss from inadequate or failed internal processes, people and systems, or
from external events (¶ 644)
Examples of risks covered

 Internal and external fraud
 Legal risks
 Damages to customers
 Losses arising out of labour, health and safety, diversity, personal injury, etc.
 Damage to physical assets
 Business interruption
Examples of risks not covered
 Reputational risk
 Strategic errors
84
Source: Text
Basel II – Operational Risk Charges
Basic Indicator Approach (¶¶ 649-651)

 15% of bank’s average annual gross income over previous three years
Standardised Approach (¶¶ 652-654, ¶¶ 660-663)
 Capital charge for each of 8 business lines calculated against average annual gross
income for business line times:
 18% for corporate finance (15% transitional charge within EU if major activity)
 18% for trading and sales (15% transitional charge within EU if major activity)
 12% for retail banking
 15% for commercial banking
 18% for payment and settlement
 15% for agency services
 12% for asset management
 12% for retail brokerage
Advanced Measurement Approach (¶¶ 655-659, ¶¶ 664-679)
 Calculated on basis of internal operational risk management system approved by national
regulator
85
Source: Text
Chapter 4
Basel II – Second Pillar
Supervisory Review
Basel II – Supervisory review
Four key principles of supervisory review (¶¶ 725-760)

 Principle 1: Banks should have process for assessing overall capital adequacy in relation
to risk profile and strategy for maintaining capital levels. Five main features of rigorous
process:
 Board and senior management oversight
 Sound capital assessment
 Comprehensive risk analysis (credit risk, operational risk, market risk, interest rate
risk in banking book, liquidity risk, other risk)
 Monitoring and reporting
 Internal control review
 Principle 2: Supervisors should review and evaluate banks’ internal capital adequacy
assessments and strategies, as well as ability to monitor and ensure compliance with
ratios. Supervisors should take appropriate action if not satisfied.
 Principle 3: Supervisors should expect banks to operate above minimum ratios and
should have ability to require banks to hold capital in excess of minimum
 Principle 4: Supervisors should seek to intervene at early stage and require rapid
remedial action
87
Source: Text
Specific issues (¶¶ 761-778)

 Interest rate risk in banking book: Basel II treats interest rate risk under Second Pillar
of supervisory review (rather than First Pillar of regulatory capital) due to differences in
methods banks use to handle risk
 Credit risk: Supervisory review is appropriate to regulate stress tests under IRB
approach, definition of default used to determine PD and/or LGD and EAD, residual risk,
credit concentration risk and operational risk
Other issues (¶¶ 779-783)

 Supervisory transparency and accountability: Supervisors should make publicly
available criteria used in review of banks’ internal capital assessments
 Enhanced cross-border communication and cooperation: Basel Committee supports
pragmatic provision of close and continuous dialogue between industry participants and
supervisors, as well as between supervisors (without changing legal responsibilities of
national regulators).
88
Source: Text
Supervisory review process for securitisation (¶¶ 784-807)

 Economic substance: Supervisory capital requirements may vary from those specified in
First Pillar if would not adequately and sufficiently reflect risks of exposure
 Maturity: Supervisors will review documentation to ensure that maturity mismatches not
artificially created to reduce capital requirements
 Correlation: Supervisors may review banks’ assessment of actual correlations between
assets in pools and how that is reflected in capital calculation; with ability to increase
capital if correlation not appropriately reflected
 Significant risk transfer: Although securitisation may occur for reasons other than risk
transfer (i.e., funding), where risk transfer is insufficient or non-existent supervisors can
deny capital relief
 Market innovations: Supervisors can take account of new features either through First
Pillar changes in minimum capital requirements or Second Pillar supervisory action
 Implicit Support: If banks engage in implicit support more than once, supervisors must
require disclosure and may apply one or more of (a) refusing further capital relief for
securitised assets, for period of time or permanently, (b) applying conversion factor to all
securitised assets so as to hold capital against them, or (c) requiring banks to hold capital
in excess of minimum requirements
89
Source: Text
Supervisory review process for securitisation (¶¶ 784-807) (cont’d)

 Residual risks: Supervisors will expect banks to consider expected losses in economic
capital, as those losses not usually transferred in securitisation
 Call provisions: May not be used to absorb losses or asset deterioration; supervisors
may require review of bank’s decision to call prior to exercise
 Early amortisation: Supervisors should review how banks internally measure, monitor
and manage risks associated with securitisations of revolving facilities; following factors
should be considered when analysing excess spread triggers:
 interest payments by borrowers on underlying receivables
 other fees and charges to be paid
 gross charge-offs
 principal payments
 recoveries on charged-off loans
 interchange income
 interest paid on investors’ certificates
 relevant macro-economic factors
90
Source: Text
Chapter 5
Basel II – Third Pillar
Market Discipline
Basel II – Disclosure (Securitisation)
Objective (¶¶ 809-810)

 Impose market discipline on banks by requiring disclosure of key information relevant to
banks’ risks and capital
Qualitative Disclosures for Securitisation (¶ 820, Table 8)

 Bank’s objectives for, and roles played by it in, securitisation process
 Bank’s accounting objectives for securitisation
 Whether treated as sales or financings
 Whether bank recognises gain on sale
 Key assumptions used by bank for valuing retained interests
 Bank’s treatment of synthetic securitisations
 Names of rating agencies used by bank and types of exposures rated by each agency
92
Source: Text
Basel II – Disclosure (Securitisation)
Quantitative Disclosures for Securitisation (¶ 820, Table 8)

 Total outstanding exposures securitised by bank subject to securitisation framework
 For exposures securitised by bank subject to framework (in each case broken down by
exposure type):
 Amount of impaired/past due assets
 Losses recognised by bank during current period
 Aggregate amount of securitisation exposures retained or purchased by bank, broken
down by exposure type
 Aggregate amount of securitisation exposures retained or purchased by bank, broken
down by “reasonable number” of risk bands (deducted exposures disclosed separately)
 Aggregate amount of securitised revolving exposures segregated by originator’s interest
and investors’ interest
 Summary of current year’s securitisation activity, including aggregate amount of
exposures securitised and gain or loss on sale, by asset type
93
Source: Text
Chapter 6
Some Observations
Basel II – Observations
Open Issues
 Will banks cope (implementing systems)?
 Will regulators cope (monitoring systems and data)?
 Will inconsistencies be minimised?
 Inconsistent rules in Basel II itself (e.g. corporate risk weights vs. securitisation risk
weights)
 Inconsistent national rules finally adopted by regulators
 Inconsistent application by supervisors (including different supervision of banks, vs.
securities firms, vs. insurance companies, vs. non-regulated financial companies)
 Will regulators provide recognition of double-default effects for pools of exposures or stick
with substitution?
 Will impractical operational requirements for IAA be addressed?
 Will the definition of defaulted assets be extended beyond 90 days?
95
Source: Text
Impact on financial markets

 Spread tightening as capital costs of holding “winners” drops:
 ABS tranches rated BBB and higher
 Corporates rated BBB or higher
 Non-OECD sovereigns rated above BB+
 Spread widening/credit tightening as capital costs of holding “losers” increases:
 Lower rated banks, corporates and ABS
 OECD sovereigns rated below AA- (but banks may hold for liquidity purposes anyway)
 Non-bank equities; non-core high operating cost activities (asset management)
96
Source: Text
Impact on banks
 Banks with more Basel II winners in portfolio benefit
 Banks with more Basel II losers in portfolio suffer
 Possible divestitures of capital-heavy businesses
 Insurance
 Asset management
 Non-bank equities
 Impact on corporate lending activities
 Return of high-quality corporates to banks as borrowers
 Credit less available to lower-quality borrowers
 Tiering of SME market – local banks for relationship lending, larger banks for credit-
based lending
97
Source: Text
Impact on securitisation markets

 Will motivate banks to securitise higher risk weighted assets and keep lower risk weighted
assets
 Will cost more to securitise, due to higher capital for lower rated tranches and unfunded
commitments (motivating banks to seek non-regulated investor base and lower cost
liquidity alternatives)
 Higher costs may slow growth of securitisation generally, reducing banks’ ability to
disperse credit risks throughout the financial system
 Securitisation volumes may rise in certain products to remove them from banks’ balance
sheets:
 Credit cards – due to capital held against unfunded commitments
 Commercial mortgages – due to higher capital charges against lower quality
exposures
 Loans – due to higher capital charges against lower quality exposures
 Covered bonds
 If cheaper to hold mortgages on balance sheet under Basel II, then covered bonds
advantages over securitisation
 But will regulators limit quantity of covered bond issuances? (FSA’s 4% suggestion)
98
Source: Text
Impact on ABCP conduits

 Motivation to hold assets in ABCP conduit (rather than on-balance sheet for risk-based
capital purposes) not as strong under Basel II
 IRB banks have much lower capital for many exposures on balance sheet
 Use of ABCP conduits may still help banks meet accounting objectives and
generates non-lending income for sponsor bank
 New capital costs for liquidity may motivate move away from traditional 0% liquidity
commitments
 Less liquidity
 Liquidity provided in new forms: e.g., market value swaps, trading book positions
 Funding provided in new forms: e.g., repos
99
Source: Text
How to contact us:
Goldman Sachs Mayer, Brown, Rowe & Maw

Christoph Gugelmann Jason Kravitt
Goldman Sachs Mayer, Brown, Rowe & Maw
Peterborough Court 1675 Broadway
133 Fleet Street New York, New York 10019-5820
London EC4A 2BB U.S.A.
England Tel: +1 212 506 2622
Tel: +44 20 7552 3185 E-mail: jkravitt@mayerbrownrowe.com
E-mail: christoph.gugelmann@gs.com
Rob Hugi
Peter Biendarra 71 South Wacker Drive
Goldman Sachs 39th Floor
Peterborough Court Chicago, Illinois 60606
133 Fleet Street U.S.A.
London EC4A 2BB Tel: +1 312 7017121
England E-mail: rhugi@mayerbrownrowe.com
Tel: +44 20 7552 0546
E-mail: peter.biendarra@gs.com Mark Nicolaides
Mayer, Brown, Rowe & Maw
Alexei Zabudkin 11 Pilgrim Street
Goldman Sachs London EC4V 6RW
Friedrich-Ebert-Anlage 49 England
D-60308 Frankfurt am Main Tel: +44 20 7246 6232
Germany E-mail: mnicolaides@mayerbrownrowe.com
Tel: +49 69 7532 1304
E-mail: alexei.zabudkin@gs.com
100

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The Basel II Capital Accord

Chapter 1 – Basel basics

Chapter 2 – Basel II capital charges (cont’d)

Chapter 2 – Basel II capital charges (cont’d)

Chapter 3 – Basel II operational risk charges 84

Chapter 4 – Supervisory Review – Second Pillar

Chapter 5 – Market discipline – Third Pillar

Chapter 6 – Some observations

Contact Details 100

Basel II introduced to:

 Much more complex and risk sensitive

Unless otherwise indicated, all references to paragraph numbers in

Applied on consolidated basis to Insurance entities

Minimum Capital Charges: Minimum capital requirements based on market, credit

Supervisory Review: Qualitative supervision by regulators of internal bank risk control

Credit risk charges (¶¶ 40-643)

Operational risk charges (¶¶ 644-683)

Market risk charges (¶¶ 684-718)

External credit assessment institution (ECAI)(rating agency) recognised/

If two assessments, higher risk weight applied (¶ 97)

Solicited Subject to national discretion, unsolicited ratings recognised (¶ 108)

IRB capital requirements for credit risk, operational risk

BIS Committee and/or national

OECD Russia 68% Baa3/BBB-

* Inputs: average rating agency values

Sovereigns – Standardised Banks (¶¶ 53-59)

 Risk weights for sovereign exposures:

AAA to A+ to BBB+ BB+ to Below

 Risk weights may also be based on ECA risk scores

Sovereigns – IRB Banks (¶¶ 270-272)

below B- 150% 150% below B- 226%

unrated 100% 50% Unrated*** NA

* Using inputs of average rating agency

Banks – Standardised Banks (¶¶ 60-65)

AAA to A+ to BBB+ BB+ to Below

Banks – IRB Banks (¶¶ 270-272)

A 50% 100% A 24% - 28%

unrated 100% 100% below B- 226%

* Using inputs of rating agency values

 Corporates rated  Corporates rated ** Internal PD estimate to be applied.

Corporates – Standardised Banks (¶¶ 66-68)

2 options, selected by national regulator to apply for all banks in jurisdiction:

AAA to A+ to BBB+ Below

Corporates – IRB Banks (¶¶ 270-274)

Correlation (R) = 0.12 × (1 – EXP (-50 × PD)) / (1 – EXP (-50)) +

 Internally * PD and LGD inputs provided by bank

Retail – Standardised Banks (¶¶ 69-71)

Retail – IRB Banks (¶¶ 326-338)

Real Estate – In a Nutshell

* Subject to conditions *** Using PD of 1% and LGD of 10%

Real Estate – Standardised Banks

Residential Real Estate (¶¶ 72-73)

Commercial Real Estate (¶ 74)

Real Estate – IRB Banks

 High volatility commercial real estate (HVCRE) (¶¶ 280-284):

Covered Bonds – In a Nutshell

Basel I (CRD) Basel II (CRD)

* Italy, Portugal, Sweden, UK * Requires rating of AAA to AA-

Specialised Lending – In a Nutshell

All 100% All 100% Five Classes of Specialised Lending:

Generally: For exposures other than HVCRE, banks

Off Balance Sheet Items – Standardised Banks (¶¶ 82-89)