Basle Securitisation capital requirements set to change again:
Vinod Kothari

Links Go back to the Page on BIS proposals

The Bank for International Settlements continues to make progress towards finalizing draft of Basle II based on representations received on the third consultative paper (CP3). On 15^th Jan 2004, the Bank released a set of proposals related to securitisation transactions which has apparently reconciled the earlier approach in light of the representations made by securitisation industry players world-over.

The securitisation-related proposals appear as an attachment to a Press release of 15^th Jan by BIS, which also says that more detailed proposals on securitisation will be released “shortly”. The proposed changes relate mostly to the Internal Ratings-based approach. It is notable that the capital computation for securitisation under CP3 could be either based on standardized approach or Internal ratings-based (IRB) approach. These two approaches could be used respectively where the assets in question were risk-weighted using the relevant approach. Under the IRB approach, there were two approaches again – one, called ratings-based approach (RBA) where risk weights were generated based on the granularity of the pool (N) and the relative size of the senior tranches to the tranche in question (Q); and two, called Supervisory Formula (SF), applicable in cases where ratings or inferred ratings were not available, where the risk weights were based on a recursive formula.

The major changes are discussed below:

Changes related to the SF approach:

The SF approach under CP3 was quite complicated: the formula itself was daunting. The proposed changes mostly relate to the SF approach. The proposed changes outlined in the press release are as under:

 

1. IAA approach: A new approach called Internal Assessment approach is being introduced. The IAA would be applicable only to exposures to ABCP conduits that have an internal rating equivalent of investment-grade at inception. It would not be available beyond this limited scope. Under this approach, banks would derive their internal assessments of such exposures based on rating agency criteria for the asset type purchased by the conduit, including those criteria pertaining to the amount of seller-provided credit enhancement needed to achieve a given rating equivalent. The notional amount of the exposure would then be assigned the risk weight corresponding to the external rating equivalent under the Ratings-Based Approach (RBA).
2. Simplified supervisory formula: Notably, in CP3, for computation of the risk weights under SF, there were 5 inputs: K_IRB (implying the capital charge had the asset in question not been securitised) L (extent of subordination available at the tranche level), T (thickness of the tranche), N (effective number of exposures) and LGD (loss given default). The simplified supervisory formula removes the LGD from the computation, as it is implicit in the K_IRB. This might appreciably make the complicated SF computation easier.

Consistency for capital charge of originating and investing bank:

The proposed capital charges under CP3 were different for the investing and the originating bank. In case of the originating bank, in case of retained tranches with rating of BB+ or below, there was a deduction from capital, while in case of the investing bank, at that level, there was a provision for 350% risk weight, with deduction applicable only for B+ or below rated tranches. In case of the IRB approach, an originating bank was supposed to deduct from capital any position upto the K_IRB level.

 

The proposed changes would allow a bank to recognize external ratings for a retained tranche upto BB- (as in case of investing banks under the standardized approach), even if the same falls below the K_IRB computation.

 

It is not clear from the press release whether this would be applicable to the standardized approach as well.

RBA risk-weights changed:

The RBA risk-weights are applicable for a tranche which is either rated or has an inferred rating. These risk weighs were based on three factors: ratings, granularity (N) and the relative seniority of the subject tranche (Q). Accordingly, for several rating classes, there were 3 columns of risk weights under CP3. The first column, with the least risk weights, was applicable for highly granular pools (N being 500 or more) with a highly senior tranche. Column 3 was applicable for a concentric pool with N being les than 6. Column 2 was applicable for all other classes.

 

The 3 columns apparently remain the same, but the risk weights for the senior classes have now been further differentiated. In other words, there are more rows in the Table now. The revised Table is as under:

 

External Rating (Illustrative)	Risk weights for senior tranches & eligible IAA	Base risk       weights	Risk weights for tranches backed by non-granular pools
Aaa	7%	12%	20%
Aa	8%	15%	25%
A1	10%	18%	35%
A2	12%	20%
A3	20%	35%
Baa1	35%	50%	50%
Baa2	60%	75%	75%
Baa3	100%	100%	100%
Ba1	250%	250%	250%
Ba2	425%	425%	425%
Ba3	650%	650%	650%
Below Ba3 and unrated	Deduction	Deduction	Deduction