The New Basel Capital Accord Under the Standardised Approach

DRAFT

C O N F I D E N T I A L

Quantitative Impact Analysis of

The New Basel Capital Accord under the Standardised Approach

Worksheet for Calculation of Capital Adequacy Ratio of

an Authorized Institution incorporated in Hong Kong

(Combined Position)

As at 31 December 2000

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Introduction

1. The objective of this exercise is to gather information on the possible impact that the New Capital Accord may have on the capital requirements of reporting institutions under the standardised approach.

1. For details of the new capital proposals, please refer to the consultative package released by the Basel Committee in January 2001.

General Instructions

1. This exercise covers the solo position of the reporting institution only. Please report figures as at the end of December 2000 in combined position (i.e. including the institution’s Hong Kong and overseas branches).

1. To facilitate completion by the reporting institution, the design of the worksheet is similar to that of the existing return on capital adequacy ratio (MA(BS)3). Please follow the completion instructions of MA(BS)3 for items not specially mentioned in the following paragraphs (e.g. residential mortgages).

1. In this worksheet, the calculation method for capital base remains the same while there are changes to the application of risk weights of on- and off-balance sheet items (see Explanatory Notes below).

1. The reporting institution should report the principal amount of each on- and off-balance sheet item before and after taking account of allowable credit risk mitigation (CRM) techniques (see paras. 34-38 for more guidance). The principal amount after CRM will be used for calculating the weighted amount of each item.

1. All assets that are past due for more than 3 months should be reported under item 9 of the worksheet (see paras. 26-28 for more details).

1. The term “claims” used in this worksheet include claims guaranteed by a counterparty or claims secured by eligible collateral issued by that counterparty upon which the risk weight is based.

1. It is accepted that some reporting institutions may not have exact data on all requested information and therefore estimates are acceptable as long as they are representative of the institution’s portfolio.

1. The specific assumptions or options to be used for this exercise are highlighted in the Explanatory Notes below.

Explanatory Notes

External Credit Assessments

1. In the New Accord, there are significant changes to the determination of risk weights applied to credit exposures. Unlike the 1988 Accord, the sovereign risk weights will no longer depend on whether the country is a member of the OECD. Instead, the risk weights for exposures will depend on ratings assigned by external credit assessment institutions (ECAIs) approved by national supervisors. Similarly, the use of external credit ratings will be applied to corporate exposures. The New Accord also allows national supervisors to recognise the country risk scores assigned to sovereigns by Export Credit Agencies that subscribe to the OECD 1999 methodology and publish their risk score for banks’ use.

1. In future, the HKMA will determine the eligibility of ECAIs and the mapping to risk buckets. For the sake of simplicity, only ratings from S&P should be used for this exercise.

Claims on Central Governments and Central Banks – Item 2

1. The New Accord allows national supervisors to apply a lower risk weight to banks’ exposures to the sovereign of incorporation denominated in domestic currency and funded in that currency. National supervisors may extend this treatment to portions of claims guaranteed by the sovereign (or central bank), where the guarantee is denominated in the domestic currency and the exposure is funded in that currency. As the S&P sovereign ratings (long term) of Hong Kong are AA- for domestic currency debt and A+ for foreign currency debt, exposures to the Hong Kong SAR Government (or the Exchange Fund) in HKD will already qualify for a 0% risk weight under the New Accord. There is no need for the HKMA to apply this discretion for the purpose of this exercise. Exposures to the Hong Kong SAR Government (or the Exchange Fund) in other currencies, on the other hand, will be subject to a risk weight of 20%. Please use these risk weights when completing the worksheet.

1. When national supervisors of other jurisdictions exercise the above discretion, the HKMA may permit its AIs to apply the same risk weight to domestic currency exposures to that sovereign (or central bank) funded in that currency. For the purpose of this exercise, we assume that other national supervisors will also exercise this discretion. Therefore, the risk weight of claims on other sovereigns denominated and funded in the currency of that sovereign should be 0% for the purpose of this exercise.

Claims on Public Sector Entities (“PSEs”) – Item 3

1. Under the New Accord, claims on domestic PSEs will be treated as claims on banks of that country. Subject to national discretion, claims on domestic PSEs may also be treated as claims on the sovereigns in whose jurisdictions the PSEs are established. Where this discretion is exercised, other national supervisors may allow their banks to risk weight claims on such PSEs in the same manner.

1. For the purpose of this exercise, PSEs in Hong Kong should remain subject to a risk weight of 20%. Claims on PSEs in other countries should be treated in the same manner as claims on banks (see paras. 20-22 below).

Claims on Multilateral Development Banks (“MDBs”) and Specified International Organisations – Item 4

1. For the purpose of this exercise, the MDBs mentioned below are deemed to be eligible for a risk weight of 0%. MDBs not mentioned below will be subject to the same treatment as banks according to their external credit ratings and maturity of the transactions.

1. MDBs qualifying for a risk weight of 0% are:

• the World Bank Group comprising the International Bank for Reconstruction and Development (IBRD) and the International Finance Corporation (IFC);
• the Asian Development Bank (ADB);
• the African Development Bank (AFDB);
• the European Bank for Reconstruction and Development (EBRD);
• the Inter-American Development Bank (IADB);
• the European Investment Bank (EIB);
• the Nordic Investment Bank (NIB);
• the Caribbean Development Bank (CDB); and
• the Council of Europe Development Bank (CEDB).

1. The specified international organisations deemed to have 0% risk weight are:

• the Bank of International Settlement (BIS);
• the International Monetary Fund (IMF);
• the European Central Bank (ECB); and
• the European Community.

Claims on Banks – Item 5

1. National supervisors may choose either Option 1 or Option 2 for determining the risk weights of banks (see paras. 29 to 33 of the Consultative Document on “The New Basel Capital Accord”). Option 2 is adopted for this exercise. Under this option, claims on both rated and unrated banks with an original maturity of three months or less (i.e. short-term claims) are subject to a preferential risk weight that is one category more favourable than the risk weight of the bank itself. But this preferential risk weight is subject to a floor of 20% and is not available to banks with a risk weight of 150%.

1. Furthermore, when other national supervisors have chosen to apply the preferential treatment for claims on their sovereigns as described in para. 13, a national supervisor may apply a risk weight that is one category less favourable than that assigned to claims on the sovereign of incorporation under both options 1 and 2. This preferential risk weight is subject to a floor of 20% and only applicable to bank claims with an original maturity of 3 months or less and also denominated and funded in the domestic currency. For the sake of simplicity, it is assumed that this discretion is not exercised and all such claims will be risk-weighted in accordance with Option 2 mentioned above.

1. The term “short term” used in the worksheet refers to original maturity of 3 months or less and “long term” refers to original maturity of more than 3 months.

Claims on Corporates – Item 6

1. Claims on corporates should be risk-weighted according to the corporate’s external credit rating (see para. 35 of the Consultative Document on “The New Basel Capital Accord”). For the purpose of this exercise, claims on securities firms are treated as claims on corporates.

1. If the reporting institution estimates that less than 10% of its corporate portfolio by amount is rated, it may choose to report all corporates as unrated subject to a risk weight of 100%. If this option is taken, please insert a “” in the following box.

Option taken

1. As part of the supervisory review process, supervisors may consider whether the credit quality of unrated corporate claims held by individual banks should warrant a standard risk weight higher than 100%. Higher-risk assets, e.g. venture capital and private equity investments, may also be subject to a higher risk weight of 150%. The HKMA does not specify higher risk weights for these exposures for the purpose of this exercise.

Assets that are past due for more than 3 months – Item 9

1. 150% risk weight will be applied to the unsecured portion of assets that are past due for more than 3 months, net of specific provision. Eligible collateral and guarantees for the purpose of defining the secured portion of the past due assets will include those mentioned in the credit risk mitigation techniques (please refer to Part 2 Section II B of the Consultative Document “The New Basel Capital Accord” for details). Supervisors can recognise a wider range of eligible collateral for the purpose of defining the secured portion of the past due assets within a transitional period of 3 years.

1. For the purpose of this exercise, except those collateral mentioned in the Consultative Document, no other collateral (including property) is deemed eligible.

1. To provide the HKMA with some ideas of the effect of excluding property collateral on the capital requirement, please also indicate in item 9.1 of the worksheet the amount of past due assets secured by properties before and after excluding the secured portion. For the purpose of this item, the secured portion of a past due asset refers to the lower of the amount of the past due asset and the adjusted value of the property collateral (i.e. after applying a 30% haircut to the net realisable value of the property).

Off-balance Sheet Items

1. The current framework for calculating the risk-weighted exposures of off-balance sheet transactions under the standardised approach will be retained with some exceptions. The risk weights of off-balance sheet items will also be based on the method of external credit assessments for on-balance sheet items mentioned above.

1. To simplify the reporting for this exercise, the reporting institution is allowed to use the same principal amount and total weighted amount of off-balance sheet exposures as reported to the HKMA in the December 2000 return on capital adequacy ratio for items 14 through 22.

1. For item 23, the credit conversion factor for business commitments with original maturity up to one year will be 20%, with the exception that a 0% credit conversion factor will be applied to commitments that are unconditionally cancellable, or effectively provide for automatic cancellation, due to deterioration in a borrower’s creditworthiness, at any time by the bank without prior notice. The credit conversion factor for commitments with original maturity over one year under item 24 will continue to be 50%. These off-balance sheet items should be weighted according to the risk weight applicable to the relevant asset or counterparty, where appropriate.

1. Although the New Accord removes the 50% ceiling on counterparty risk weights of derivatives transactions, for the sake of simplicity, the credit conversion factors and risk weights under the existing framework will continue to apply under item 25. Please insert the actual figures of principal amount and total weighted amount as reported to the HKMA for position at end 12/2000.

Operational Risk Capital Charges – Item 27.3

1. For the calculation of capital charges for operational risk under this exercise, the Basic Indicator Approach is to be adopted. Gross income for year 2000 is used as the proxy for an institution’s overall operational risk exposures. The capital charges are to be computed as 30% of gross income (the “” factor mentioned in the Consultation Document is 30%). Please note that sources of income that are extraordinary or non-recurring in nature, such as profit/(loss) on sale of fixed assets and dividends from subsidiary/associated companies and other investments, should be excluded from the amount of gross income.

Credit Risk Mitigation Techniques

1. A wider range of credit risk mitigants is proposed by the Consultative Document of the New Capital Accord. Please indicate below the types of mitigation techniques your institution has used for the purpose of completing the worksheet. If the reporting institution considers that the changes proposed under the New Accord for credit risk mitigation will not have a significant impact on their capital adequacy ratio, they may use the existing credit risk mitigation methods for the purpose of completing this worksheet.

1. For the comprehensive approach mentioned in the Consultative Document, national supervisors may allow banks to use either the standard supervisory haircuts or their own estimates when calculating the collateral haircuts. For the sake of simplicity, institutions opting for the comprehensive approach in this exercise should only use the standard supervisory haircuts set out by the Basel Committee. Please refer to Part 2 Section II B of the Consultative Document “The New Basel Capital Accord” for details of the haircuts.

1. Moreover, recognising the fact that the credit risk may be very small on well-documented repo transactions in liquid securities conducted with experienced counterparties and settled quickly across proven settlement systems. National supervisors may choose not to apply the haircuts specified in the comprehensive approach and may instead apply a zero H for transactions where conditions for a zero w are satisfied and the counterparty is a core market participant. A zero H and a zero w is assumed in this exercise for such repo transactions.

1. Please insert a “” in the boxes below where applicable.

Credit mitigation techniques proposed by the Consultative Document

(Please refer to Part 2 Section II B of the Consultative Document “The New Basel Capital Accord” for details.)

Treatment of collateral:

Comprehensive approach; or

Simple approach

On-balance sheet netting

Use of guarantees

Use of credit derivatives

OR

Existing credit mitigation techniques

Use of guarantees

Use of credit derivatives

1. An example of how to apply credit risk mitigation techniques under the simple and comprehensive approaches is given below to demonstrate the different reporting treatment of the two approaches. Reporting institutions should refer to the Consultative Document for situations not covered in the example.

Example on Application of Credit Risk Mitigation Techniques

An unrated corporate borrower with a risk weight of 100% borrowed HK$100 M from an authorized institution. The borrower placed A-rated corporate bonds valued at HK$80 M with 6 years of residual maturity as collateral. The collateral attracts a 50% risk weight. The bonds are assumed to be eligible collateral under the New Accord.

Simple Approach

Working:

• Weighted amount of secured portion: HK$80 M x 50% = HK$40 M
• Weighted amount of unsecured portion: HK$20 M x 100% = HK$20 M
• Total weighted amount of asset: HK$40 M + HK$20 M = HK$60 M

Reporting method:

• Report HK$100 M as the principal amount before CRM for the corporate claim with a 100% risk weight (item 6.1c).
• Report HK$20 M as the principal amount after CRM for the unsecured portion of the corporate claim with a 100% risk weight (item 6.1c).
• Report HK$80 M as the principal amount after CRM for the secured portion of the corporate claim. As this portion of the claim receives a lower risk weight of 50% applicable to the collateral instrument, it should be reported under item 6.1b as a claim secured by collateral issued by an A-rated corporate.
• The weighted amount should be calculated by using the principal amount after CRM multiplied by the appropriate risk weight. This means that HK$40 M (HK$80 M x 50%) is the weighted amount of the secured portion of the corporate claim and HK$20 M (HK$20 M x 100%) is the weighted amount of the unsecured portion of the corporate claim.

Comprehensive Approach

Working:

• The standard supervisory haircut for the collateral is 12%.
• The adjusted value of collateral: HK$80 M x [1/(1+12%)] = HK$71.429 M
• The amount of unsecured exposure: HK$100 M - HK$71.429 M = HK$28.571 M
• The floor factor w for collateral is 0.15.
• As the value of the exposure exceeds the adjusted value of collateral, the following formula applies:

Weighted amount of asset = r x [E – (1 – w) x CA] where

r: the risk weight of the unsecured exposure,

E: value of unsecured exposure,

w: the floor factor applied to the secured portion, and

CA: the adjusted value of the collateral.

(Please refer to the consultative package for details of the formulae applied.)

• Weighted amount of asset: 100% x [HK$100 M - (1 - 0.15) x HK$71.429 M]

= HK$39.286 M

Reporting method:

• Report HK$100 M as the principal amount before CRM for the corporate claim with a 100% risk weight (item 6.1c).
• Report HK$39.286 M as the principal amount after CRM under item 6.1c (i.e. after taking account of the adjusted value and floor factor w of the collateral).
• Report HK$39.286 M as the weighted amount of the corporate claim under item 6.1c, after applying a 100% risk weight applicable to the corporate borrower.

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