Finalized Guidance Document Concerning the Implementation of Basel III

Addressing Reliance on External Credit Ratings and Minimizing Cliff Effects The following is a summary of this component. • A major consequence under Basel II was to rely excessively on external ratings for regulatory capital requirements • This resulted in the neglect of bank’s own independent internal assessment of risks to a certain degree • Rating agencies have an incentive to produce ‘’good ratings’’ • Given the Basel II rules banks have an incentive to seek ratings just above the ‘’cliff’’ • For e.g. the Standardized Approach prescribes a higher risk weight to corporate exposures that are rated below BB- (150%) than for unrated exposures (100%)- This provides incentives to banks not to get ratings for companies that are likely to be rated below BB- • Applicable under Standardized Approach Further elaboration on the above are given below.