Finalized Guidance Document Concerning the Implementation of Basel III

Standardised Inferred Rating Treatment for Long-Term Exposures • Relates to determining of an inferred rating under Standardized Approach Para 99 of Basel II framework ‘’Issuer vs issues assessment para 99 ‘’if either the issuer or a single issue has a low quality assessment (mapping into a risk weight equal or higher than that which applies to unrated claims), an unassessed claim on the same counterparty will be assigned the same risk weight as is applicable to the low quality assessment. For e.g. if a Corporate issuer has subordinated debt rated single -B and a bank holds an unrated senior exposure to that issuer, the unrated senior exposure must be assigned to the risk weight category corresponding to the single –B rating (eg the 150% risk weight), even if there are other rated senior exposures of the issuer (eg AA) In specific, 118. Para. 99 of the Basel II text would be modified as follows: 99. Where a bank invests in a particular issue that has an issue-specific assessment, the risk weight of the claim will be based on this assessment. Where the bank’s claim is not an investment in a specific assessed issue, the following general principles apply. • In circumstances where the borrower has a specific assessment for an issued debt – but the bank’s claim is not an investment in this particular debt – a high quality credit assessment (one which maps into a risk weight lower than that which applies to an unrated claim) on that specific debt may only be applied to the bank’s unassessed claim if this claim ranks pari passu or senior to the claim with an assessment in all respects. If not, the credit assessment cannot be used and the unassessed claim will receive the risk weight for unrated claims. • In circumstances where the borrower has an issuer assessment, this assessment typically applies to senior unsecured claims on that issuer. Consequently, only senior claims on that issuer will benefit from a high quality issuer assessment. Other unassessed claims of a highly assessed issuer will be treated as unrated. If either the issuer or a single issue has a low quality assessment (mapping into a risk weight equal to or higher than that which applies to unrated claims), an unassessed claim on the same counterparty that ranks pari passu or is subordinated to either the senior unsecured issuer assessment or the exposure assessment will be assigned the same risk weight as is applicable to the low quality assessment. 8.2. Incentive to Avoid Getting Exposures Rated As a summary: • Revised Para 733 of the Basel II framework (Supervisory Review Process Pillar 2) • Banks should internally assess if the risk weights applied under the Standardized Approach are appropriate for their inherent risk. • If it turns out that that the inherent risk is higher, then the bank should consider the higher degree of risk 119. Para. 733 of the Basel II text will read as follows: 733. Credit risk: Banks should have methodologies that enable them to assess the credit risk involved in exposures to individual borrowers or counterparties as well as at the portfolio level. Banks should assess exposures, regardless of whether they are rated or unrated, and determine whether the risk weights applied to such exposures, under the Standardized Approach, are appropriate for their inherent risk. In those instances where a bank determines that the inherent risk of such an exposure, particularly if it is unrated, is significantly higher than that implied by the risk weight to which it is assigned, the bank should consider the higher degree of credit risk in the evaluation of its overall capital adequacy. For more sophisticated banks, the credit review assessment of capital adequacy, at a minimum, should cover four areas: risk rating systems, portfolio analysis/aggregation, securitization/complex credit derivatives, and large exposures and risk concentrations. 8.3. Incorporation of IOSCO’s Code of Conduct Fundamentals for Credit Rating Agencies As a summary: • SAMA to r