Minimum Capital Requirements for Credit Risk

Banks using the advanced IRB approach must also collect and store a complete history of data on the LGD and EAD estimates associated with each facility and the key data used to derive the estimate and the person/model responsible. Banks must also collect data on the estimated and realized LGDs and EADs associated with each defaulted facility. Banks that reflect the credit risk mitigating effects of guarantees/credit derivatives through LGD must retain data on the LGD of the facility before and after evaluation of the effects of the guarantee/credit derivative. Information about the components of loss or recovery for each defaulted exposure must be retained, such as amounts recovered, source of recovery (e.g. collateral, liquidation proceeds and guarantees), time period required for recovery, and administrative costs. 16.48 Banks under the foundation approach which utilize supervisory estimates are encouraged to retain the relevant data (i.e. data on loss and recovery experience for corporate exposures under the foundation approach, data on realized losses for banks using the supervisory slotting criteria). Data maintenance: for retail exposures 16.49 Banks must retain data used in the process of allocating exposures to pools, including data on borrower and transaction risk characteristics used either directly or through use of a model, as well as data on delinquency. Banks must also retain data on the estimated PDs, LGDs and EADs, associated with pools of exposures. For defaulted exposures, banks must retain the data on the pools to which the exposure was assigned over the year prior to default and the realized outcomes on LGD and EAD. Stress tests used in assessment of capital adequacy 16.50 An IRB bank must have in place sound stress testing processes for use in the assessment of capital adequacy. Stress testing must involve identifying possible events or future changes in economic conditions that could have unfavorable effects on a bank’s credit exposures and assessment of the bank’s ability to withstand such changes. Examples of scenarios that could be used are: (1) Economic or industry downturns; (2) Market-risk events; and (3) Liquidity conditions. 16.51 In addition to the more general tests described above, the bank must perform a credit risk stress test to assess the effect of certain specific conditions on its IRB regulatory capital requirements. The test to be employed would be one chosen by the bank, subject to supervisory review. The test to be employed must be meaningful and reasonably conservative. Individual banks may develop different approaches to undertaking this stress test requirement, depending on their circumstances. For this purpose, the objective is not to require banks to consider worst-case scenarios. The bank’s stress test in this context should, however, consider at least the effect of mild recession scenarios. In this case, one example might be to use two consecutive quarters of zero growth to assess the effect on the bank’s PDs, LGDs and EADs, taking account – on a conservative basis- of the bank’s international diversification. 16.52 Whatever method is used, the bank must include a consideration of the following sources of information. First, a bank’s own data should allow estimation of the ratings migration of at least some of its exposures. Second, banks should consider information about the impact of smaller deterioration in the credit environment on a bank’s ratings, giving some information on the likely effect of bigger, stress circumstances. Third, banks should evaluate evidence of ratings migration in external ratings. This would include the bank broadly matching its buckets to rating categories. Section 5: Corporate Governance and Oversight Corporate governance