Risk Components for Corporate, Sovereign and Bank Exposures

Under either approach, CRM in the form of guarantees and credit derivatives must not reflect the effect of double default (see paragraph 16.101 ). As such, to the extent that the CRM is recognized by the bank, the adjusted risk weight will not be less than that of a comparable direct exposure to the protection provider. Consistent with the standardized approach, banks may choose not to recognize credit protection if doing so would result in a higher capital requirement. Treatment of guarantees and credit derivatives: recognition under the foundation approach 12.23 For banks using the foundation approach for LGD, the approach to guarantees and credit derivatives closely follows the treatment under the standardized approach as specified in paragraphs 9.69 to 9.83 . The range of eligible guarantors is the same as under the standardized approach except that companies that are internally rated may also be recognized under the foundation approach. To receive recognition, the requirements outlined in paragraphs 9.69 to 9.74 of the standardized approach must be met. 12.24 Eligible guarantees from eligible guarantors will be recognized as follows: (1) For the covered portion of the exposure, a risk weight is derived by taking: (a) The risk-weight function appropriate to the type of guarantor, and (b) The pd appropriate to the guarantor’s borrower grade. (2) The bank may replace the LGD of the underlying transaction with the LGD applicable to the guarantee taking into account seniority and any collateralization of a guaranteed commitment. For example, when a bank has a subordinated claim on the borrower but the guarantee represents a senior claim on the guarantor this may be reflected by using an LGD applicable for senior exposures (see paragraph 12.6) instead of an LGD applicable for subordinated exposures. (3) In case the bank applies the standardized approach to direct exposures to the guarantor it may only recognize the guarantee by applying the standardized approach to the covered portion of the exposure. 12.25 The uncovered portion of the exposure is assigned the risk weight associated with the underlying obligor. 12.26 Where partial coverage exists, or where there is a currency mismatch between the underlying obligation and the credit protection, it is necessary to split the exposure into a covered and an uncovered amount. The treatment in the foundation approach follows that outlined in paragraphs 9.79 to 9.80 of the standardized approach, and depends upon whether the cover is proportional or tranched. Treatment of guarantees and credit derivatives: recognition under the advanced approach 12.27 Banks using the advanced approach for estimating LGDs may reflect the riskmitigating effect of guarantees and credit derivatives through either adjusting PD or LGD estimates. Whether adjustments are done through PD or LGD, they must be done in a consistent manner for a given guarantee or credit derivative type. In doing so, banks must not include the effect of double default in such adjustments. Thus, the adjusted risk weight must not be less than that of a comparable direct exposure to the protection provider. In case the bank applies the standardized approach to direct exposures to the guarantor it may only recognize the guarantee by applying the standardized approach to the covered portion of the exposure. In case the bank applies the F-IRB approach to direct exposures to the guarantor it may only recognize the guarantee by determining the risk weight for the comparable direct exposure to the guarantor according to the F-IRB approach.