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Basel 4: Credit Risk - the Standardised Approach

Basel 4: Credit Risk - the Standardised Approach

Bridging the gap to internal models


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Since the implementation of Basel 2, banks have been able to either use a regulatory standardised approach to calculate credit risk capital requirements, or follow an IRB approach by leveraging their internal understanding of risk measurement. This discretion has seen a rise in complaints that risk weights are not comparable across banks, and that some banks have been too aggressive in using models to drive down risk weights.

As part of the final Basel 4 standards, the Basel Committee on Banking Supervision (BCBS) finalised its reforms for the Standardised Approach (CR-SA) and the Internal Ratings Based approach (CR-IRB) for the calculation of risk weighted assets for credit risk. Under Basel 4 these issues are addressed by restricting what is accepted in the IRB approach, by applying a floor to the extent to which risk weights can be driven down by the use of internal models, and by making the Standardised Approach more risk sensitive.

The revised CR-SA largely follows the proposals set out in the BCBS's December 2015 consultation paper, therefore the changes are not as severe as banks once feared. However, under the revised CR-SA the recalibration of risk weights in most asset classes will have a direct impact on capital requirements. In this article, we discuss the potential impacts that this could have on banks' capital requirements and business models as they implement the new standard.

A companion paper in this series covers the changes to the CR-IRB.

This article is part of our Basel 4: The way ahead series discussing the Basel 4 standards. To assess the full impact of these final rules, we are leveraging the insights of our global network to publish a series of articles that focus on specific areas affected by the standards. Find the latest articles online here.

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