Minimum Capital Requirements for Credit Risk

Dilution refers to the possibility that the receivable amount is reduced through cash or non-cash credits to the receivable’s obligor 61 . For both corporate and retail receivables, unless the bank can demonstrate to its supervisor that the dilution risk for the purchasing bank is immaterial, the treatment of dilution risk must be the following: (1) At the level of either the pool as a whole (top-down approach) or the individual receivables making up the pool (bottom-up approach), the purchasing bank will estimate the one-year EL for dilution risk, also expressed in percentage of the receivables amount. Banks can utilize external and internal data to estimate EL. As with the treatments of default risk, this estimate must be computed on a stand-alone basis; that is, under the assumption of no recourse or other support from the seller or third-party guarantors. (2) For the purpose of calculating risk weights for dilution risk, the corporate risk-weight function must be used with the following settings: (a) The PD must be set equal to the estimated EL. (b) The LGD must be set at 100%. (c) An appropriate maturity treatment applies when determining the capital requirement for dilution risk. If a bank can demonstrate that the dilution risk is appropriately monitored and managed to be resolved within one year, the supervisor may allow the bank to apply a one-year maturity. 14.9 This treatment will be applied regardless of whether the underlying receivables are corporate or retail exposures, and regardless of whether the risk weights for default risk are computed using the standard IRB treatments or, for corporate receivables, the top-down treatment described above. 61 Examples include offsets or allowances arising from returns of goods sold, disputes regarding product quality, possible debts of the borrower to a receivables obligor, and any payment or promotional discounts offered by the borrower (e.g. a credit for cash payments within 30 days) Treatment of Purchase Price Discounts for Receivables 14.10 In many cases, the purchase price of receivables will reflect a discount (not to be confused with the discount concept defined in paragraphs 12.29 and 12.62 ) that provides first loss protection for default losses, dilution losses or both. To the extent that a portion of such a purchase price discount may be refunded to the seller based on the performance of the receivables, the purchaser may recognize this refundable amount as first-loss protection and hence treat this exposure under the securitization chapters 18 to 23 , while the seller providing such a refundable purchase price discount must treat the refundable amount as a first-loss position under the securitization chapters. Non-refundable purchase price discounts for receivables do not affect either the EL-provision calculation in chapter 15 or the calculation of risk-weighted assets. 14.11 When collateral or partial guarantees obtained on receivables provide first loss protection (collectively referred to as mitigants in this paragraph), and these mitigants cover default losses, dilution losses, or both, they may also be treated as first loss protection under the securitization chapters (see paragraph 22.10 ). When the same mitigant covers both default and dilution risk, banks using the Securitization Internal Ratings-Based Approach (SEC-IRBA) that are able to calculate an exposure-weighted LGD must do so as defined in paragraph 22.21 . Recognition of Credit Risk Mitigants