Basics of Risk-Based Capital

for Securitization Exposures

Speakers: Bill Falcon, PNC
Tim Mohan, Chapman and Cutler LLP

Executive Summary
Risk-based capital is equity, qualifying reserves, and qualifying capital that must be
maintained by a bank to cover risks associated with conducting day-to-day business

Risk-based capital is determined in compliance with the jurisdictional implementation of Basel I,

Basel II, and any corresponding revisions thereto

Basel I established two fundamental objectives

Basel II, A Revised Framework on International Convergence of Capital Measurement and Capital Standards

Proposed in 1999 in response to the banking crisis in the 1990s and the criticisms of Basel I

Recent changes and developments impacting the current risk-based capital framework

Basel II.5 released July 2009

Dodd-Frank Act enacted in July 2010

Intended to promote financial stability in the U.S. by improving accountability and transparency in the financial system

Basel III released in December 2010 to reform Basel II

Strengthen the soundness and stability of the international banking system

Create a framework that is fair and consistent among banks in different countries to diminish an existing source of competitive
inequality among international banks

Intended to improve the banking sectors ability to absorb shocks arising from financial and economic stress

Future of risk-based capital framework

Intersection of Dodd-Frank and Basel III

Common objective To promote prudential capital standards for the banking sector
Challenges
Are such standards applicable to all banks?
How will the reliance on credit ratings be addressed?
How do supervisors ensure a level international playing field?

Brief History of Capital Regulation

Regulatory monitoring of U.S. bank capital levels has existed since the early 20th century

Three events triggered movement toward an international regime re: capital adequacy in the
1970s/1980s

Decline in worldwide capital ratios poor economic conditions

Upheaval in the financial services industry increased competition from capital markets
In the U.S., an abandonment of many traditional devices for assuring bank safety and soundness limits on
activities of banks relaxed and caps on interest rates removed

U.S. bank regulators published capital ratios for banks in 1982 and indicated that large banks with
primary capital to asset ratios of less than 5% would be considered undercapitalized

Fed and OCC applied capital ratios (7%) to U.S. multinational banks in 1983 and moved quickly with
the other bank regulators to impose capital requirements on all U.S. banks

By 1985 nearly all Basel Committee countries placed substantial regulatory reliance on capital ratios

Basel Committee published its first consultative paper on international capital standards in
December of 1987

Basel I
Basel I Overview: International Convergence of Capital Measurements and
Capital Standards
Effective since 1988 and implemented by all Basel Committee members by the end
of 1992, Basel I established two fundamental objectives:

Strengthen the soundness and stability of the international banking system

The proposed framework should be fair and have a high degree of consistency in its
application to banks in different countries with a view to diminishing an existing source
of competitive inequality among international banks

Defined the Constituents of Capital

Tier 1 Capital core capital including equity capital and disclosed reserves
Tier 2 Capital - all other qualifying capital

Basel I
Basel I Overview: International Convergence of Capital Measurements and Capital
Standards

Established a risk weighting system

Riskless 0%
Low risk 20%
Moderate risk 50%
High risk no less than 100%

In general, corporate and consumer exposures are assigned to the 100% risk-weight category

Established the minimum capital requirements of financial institutions with the goal of minimizing
credit risk

Calculated using the Target Standard Ratio

Set a universal standard whereby 8% of a banks risk-weighted assets must be covered by Tier 1 and Tier 2 capital reserves
Tier 1 capital must cover 4% of a banks risk-weighted assets; this ratio was seen as minimally adequate to protect against credit
risk in deposit insurance-backed international banks in all Basel Committee member states

Exposure
Amount

Risk
Weight

Credit
Conversion
Factor for offbalance sheet
exposures

8%

Capital
Requirement

Basel I
Basel I Risk Weights and Credit Conversion Factors
Under Basel I, risk-based capital for securitization exposures is determined based on risk weights mapped
to measures of creditworthiness, and credit conversion factors for off-balance sheet items

Original measures of credit worthiness were broad categories such as riskless

In 2001, references to credit ratings were introduced to the U.S. framework, and specific rules for residual interests and direct
credit substitutes were adopted

Unrated exposures are generally assigned a 100% risk weight unless they are retained interests, direct credit
substitutes or other recourse positions
Basel I Credit Conversion Table
Basel I Risk-Weight Tables1
Risk weight
Long-term rating category
Example (In percent)
Highest or second highest investment grade AAA, AA
20
Third highest investment grade
A
50
Lowest investment grade
BBB
100
One category below investment grade
BB
200
Short-term rating category
Highest investment grade
Second highest investment grade
Lowest investment grade

1 Source:

Risk weight
Examples (In percent)
A-1, P-1
20
A-2, P-2
50
A-3, P-3
100

Electronic Code of Federal Regulations website (http://www.ecfr.gpoaccess.gov)

Instruments
1. Direct credit substitutes, e.g. general guarantees of indebtedness (including standby letters of
credit serving as financial guarantees for loans and securities) and acceptances (including
endorsements with the character of acceptances)
2. Certain transaction-related contingent items (e.g. performance bonds, bid bonds, warranties and
standby letters of credit related to particular transactions)
3. Short-term self-liquidating trade-related contingencies (such as documentary credits
collateralised by the underlying shipments)
4. Sale and repurchase agreements and asset sales with recourse,1 where the credit risk remains
with the bank
5. Forward asset purchases, forward forward deposits and partly-paid shares and securities,1 which
represent commitments with certain drawdown
6. Note issuance facilities and revolving underwriting facilities
7. Other commitments (e.g. formal standby facilities and credit lines) with an original maturity of
over one year
8. Similar commitments with an original maturity of up to one year, or which can be unconditionally
cancelled at any time

Credit
Conversion
Factors
100%
50%
20%
100%
100%
50%
50%
0%

Basel I
Special Rules for unrated retained interests, direct credit substitutes and recourse positions

Recourse positions

Arrangements in which a bank retains, in form or in substance, of any credit risk directly or indirectly
associated with an asset it has sold (in accordance with generally accepted accounting principles (GAAP))
that exceeds a pro rata share of the banks claim on the asset

Retained interests

If a bank has no claim on an asset it has sold, then the retention of any credit risk is recourse

On-balance sheet assets that represent an interest (including a beneficial interest) created by a transfer of
the banks assets that qualifies as a sale (in accordance with GAAP) of financial assets, whether through a
securitization or otherwise, and that exposes a bank to credit risk directly or indirectly associated with the
transferred assets that exceeds a pro rata share of the banks claim on the assets, whether through
subordination provisions or other credit enhancement techniques
Retained interests are a special category of recourse positions

Direct credit substitutes

Arrangements (e.g. letters of credit) in which a bank assumes, in form or in substance, credit risk associated
with an on- or off-balance sheet credit exposure that was not previously owned by the bank (third-party
asset) and the risk assumed by the bank exceeds the pro rata share of the banks interest in the third party
asset

Basel I
Special Rules for unrated retained interests, direct credit substitutes and recourse positions

In general, the credit-equivalent amount for an unrated recourse obligation or direct credit
substitute is the full amount of the credit-enhanced assets for which the bank directly or indirectly
retains or assumes credit risk multiplied by a 100% conversion factor

A bank that absorbs the first 10% of loss on a transaction, must maintain capital against the full amount of
the assets being supported

A bank must maintain risk-based capital for a residual interest (excluding a credit-enhancing interestonly strip) equal to the face amount of the residual interest (net of any existing associated deferred
tax liability recorded on the balance sheet), even if the amount of risk-based capital required to be
maintained exceeds the full risk-based capital requirement for the assets transferred

Basel I: ABCP Exclusion

U.S. implementation of the Basel I ABCP exclusion
With the release of FASB Fin 46(R), the U.S. banking agencies amended the risk-based capital
standards by providing a capital treatment for assets in ABCP programs that are consolidated
onto the balance sheets of sponsoring banks

Interim rule was implemented as of October 2003 and made permanent as of July 2004

Allowed sponsoring banking organizations to remove the consolidated ABCP program assets from
their risk-weighted asset bases for the purpose of calculating their risk-based capital ratios

Under the exclusion, sponsoring banking organizations would continue to hold risk-based capital
against all other risk exposure arising in connection with ABCP programs, including direct credit
substitutes, recourse obligations, residual interests, long-term liquidity facilities, and loans, in
accordance with each agencys existing risk-based capital standards

Basel I: ABCP Exclusion

Permanent Capital Relief Rule: ABCP eligible liquidity rules

Effective for periods after September 30, 2004

Provided for a 10% credit conversion factor for eligible liquidity facilities (50% for commitments over
one year)

After September 30, 2005, liquidity facilities were required to meet certain eligibility criteria in order
to qualify for the 10% or 50% Credit Conversion Factor (otherwise they were treated as direct credit
substitutes and risk-weighted not less than 100%)

Liquidity could not fund against assets that were more than 90 days past due or in default

A liquidity facility could qualify as eligible liquidity if the ineligible assets were covered by eligible credit enhancement
Funded credit enhancements such as overcollateralization, cash reserves, subordinated securities, and funded spread
accounts
Surety bonds and letters of credit issued by third parties with credit ratings of at least A
One months worth of excess spread if the excess spread is required to be captured when it falls below 4.5% and there is no
material adverse change in the banks ABCP underwriting standards

If the assets funded against were externally rated, the liquidity could not fund against the assets if the assets
were rated below investment grade at the time of the proposed liquidity funding

U.S. Rules Refining Basel I Guidelines

2001 U.S. Recourse Rules and March 30, 2005, Guidance for Calculating Capital on Program Wide Credit Enhancement
(PWCE), for ABCP Conduits
Both rules modified the risk weights for securitization exposures held by U.S. banks based on external credit ratings

With primary regulatory approval, banks were permitted to use their own internal credit ratings systems to determine the
appropriate amount of capital for PWCE (a special category of direct credit substitute). Use of these systems could not
result in a risk weight of less than 100%
U.S. regulators issued guidance on the use of internal credit ratings systems for calculating capital on PWCE provided by
banks; a weakest link approach was used to determine the capital charge

If all of the exposures in the ABCP conduit were internally rated investment grade or better, the capital charge was 8% of the amount of
the PWCE
If not, then a formula-driven approach was used to calculate capital as follows

Basel II
Basel II Overview: A Revised Framework on International Convergence of Capital
Measurement and Capital Standards

Proposed in 1999 in response to the banking crisis in the 1990s and the criticisms of Basel I

The fundamental objective of the Basel Committee's work to revise the 1988 Accord was to develop
a framework that would further strengthen the soundness and stability of the international banking
system while maintaining sufficient consistency that capital adequacy regulation would not be a
significant source of competitive inequality among internationally active banks

Expands on objectives of Basel I more comprehensive capital adequacy accord

Covers new approaches to credit risk

Adapts to the securitization of bank assets
Covers market, operational, and interest rate risk
Incorporates market-based surveillance and regulation

Basel Committee issued the final revised framework in 2004

Basel II
Three Pillars of Basel II2

Credit
Risk

Pillar 1

Pillar 2

Pillar 3

Minimum capital
requirements

Supervisory
review

Market discipline
(via disclosure)

Operational
Risk

Market
Risk

Standardized
approach

Basic indicator
approach

Foundation
internal
ratings-based
approach

Standardized
approach

Advanced
internal
ratings-based
approach
(A-IRB)

Advanced
measurement
approaches
(AMA)

Risk Measurement
Approaches
Currently proposed in the U.S.
Standardized approach as an
option for non-core banks
Other approaches available in
the international accord
Required in the U.S. final rule for
core banks, opt-in available to
non-core banks

2 Source:

GAO

Supervisory roles:
Evaluate banks internal
capital adequacy
assessments and
compliance with minimum
capital requirements

Requires banks to publicly

disclose qualitative and
quantitative inf ormation
on:
Capital ratios
Capital components

Expect and be able to

require banks to hold
capital in excess of
minimum , to address risks
not f ully captured under
Pillar 1

Intervene early to
prevent capital f rom f alling
below minimum levels

Risk assessment process

Aggregate inf ormation

underlying risk estimates

Basel II
Hierarchy of approaches for securitization exposures
According to Basel II, banks must apply the following hierarchy of approaches to determine
the risk-based capital requirement for a securitization exposure

Gains-on-Sale and Credit Enhancement Interest Only Strips (CEIOs)

Ratings-Based Approach (RBA)

Ratings-Based Approach and Use of Inferred Ratings

Internal Assessment Approach (IAA)

Supervisory Formula Approach (SFA)

Deduction from capital

Basel II
Hierarchy of approaches for securitization exposures

Gains-on-Sale and Credit Enhancement Interest Only Strips (CEIOs)

After-tax gain-on-sale resulting from a securitization is deducted from Tier 1 capital

Any portion of a CEIO that does not constitute a gain-on-sale is deducted from total capital (split evenly
between Tier 1 and Tier 2 capital)

Ratings-Based Approach (RBA)

Used if a securitization exposure is not a gain-on-sale or a CEIO

An exposure qualifies for the RBA if the exposure has an external credit rating from a Nationally Recognized
Statistical Ratings Organization (NRSRO) or has an inferred credit rating (the exposure is senior to another
securitization exposure in the transaction that has an external credit rating from an NRSRO)
An originating bank is eligible to use the RBA for a securitization exposure if

The exposure has two or more external credit ratings, or

The exposure has two or more inferred credit ratings

An investing bank is eligible to use the RBA for a securitization exposure if the exposure has one or more
external or inferred credit ratings

Basel II
Hierarchy of approaches for securitization exposures

Ratings-Based Approach (RBA) (contd)

An unrated securitization exposure has an inferred credit rating if another securitization exposure issued by
the same issuer and secured by the same underlying exposures has an external credit rating and this rated
reference exposure

Is subordinate in all respects to the unrated securitization exposure

Does not benefit from any credit enhancement that is not available to the unrated securitization exposure
Has an effective remaining maturity that is equal to or longer than the unrated securitization exposure

Securitization exposures with an inferred credit rating are treated the same as securitization exposures with
an identical external credit rating
If a securitization exposure has multiple external credit ratings or multiple inferred credit ratings, a bank is
required to use the lowest credit rating (the credit rating that would produce the highest risk-based capital
requirement)
The risk-based capital requirement per dollar of securitization exposure depends on four factors

The applicable credit rating of the exposure

Whether the credit rating reflects a long-term or short-term assessment of the exposures credit risk
Whether the exposure is a senior exposure
The granularity of the exposure

Basel II
Hierarchy of approaches for
securitization exposures

Ratings-Based Approach and Use of

Inferred Ratings

To use the charts these items must be

known

3 Source:

Explicit or inferred credit rating of the

position
Granularity of the pool (effective
number of exposures, N)
Seniority of the position

Column 2 (most favorable) of the charts

is used if N is 6 or more and the
position has the most senior claim on
the assets in the securitization pool
Column 4 (least favorable) is used if N is
less than 6
Column 3 (standard) is used in all other
cases
Note that the resecuritization
exposures in columns 5 and 6 have not
been adopted in the U.S.

Basel Committee on Banking Supervision Enhancements to the Basel II Framework, dated July 2009

ABS Risk Weights for Long-Term Credit Rating and/or Inferred

Rating Derived from a Long-Term Investment3
Long-term
Rating
AAA
AA
A+
A
ABBB+
BBB
BBBBB+
BB
BBBelow

Securitization Exposures
Resecuritization Exposures
Senior,
Non-senior, Non-granular
Senior
Non-senior
Granular
Granular
7
12
20
20
30
8
15
25
25
40
10
18
35
35
50
12
20
35
40
65
20
35
35
60
100
35
50
50
100
150
60
75
75
150
225
100
100
100
200
350
250
250
250
300
500
425
425
425
500
650
650
650
650
750
850
Deduction

ABS Risk Weights for Short-Term Credit Rating and/or Inferred

Rating Derived from a Short-Term Investment3
Short-term
Rating
A1
A2
A3
Below

Securitization Exposures
Resecuritization Exposures
Senior,
Non-senior, Non-granular
Senior
Non-senior
Granular
Granular
7
12
20
20
30
12
20
35
40
65
60
75
75
150
225
Deduction

Basel II
Hierarchy of Minimal Capital Requirements Approaches

Internal Assessment Approach (IAA)

A bank must receive written approval from its primary Federal regulator to use the IAA
A bank must satisfy the following requirements to qualify for the IAA

The banks internal credit assessments of securitization exposures must be based on publicly available credit rating criteria used by
an NRSRO
The banks internal credit assessments of securitization exposures used for risk-based capital purposes must be consistent with those
used in the banks internal risk management process, management information reporting systems, and capital adequacy assessment
process
The bank's internal credit assessment process must have sufficient granularity to identify gradations of risk
Each of the bank's internal credit assessment categories must correspond to an external credit rating of an NRSRO
The bank's internal credit assessment process, particularly the stress test factors for determining credit enhancement requirements,
must be at least as conservative as the most conservative of the publicly available credit rating criteria of the NRSROs that have
provided external credit ratings to the commercial paper issued by the ABCP program
The bank must have an effective system of controls and oversight that ensures compliance with these operational requirements and
maintains the integrity and accuracy of the internal credit assessments
The bank must have an internal audit function independent from the ABCP program business line and internal credit
assessment process that assesses at least annually whether the controls over the internal credit assessment process function
as intended
The bank must review and update each internal credit assessment whenever new material information is available, but no less
frequently than annually
A bank that elects to use the IAA for any securitization exposure to an ABCP program must use the IAA to compute risk-based capital
requirements for all securitization exposures that qualify for the IAA

Basel II
Hierarchy of Minimal Capital Requirements Approaches

Internal Assessment Approach (IAA) (contd)

A banks exposure must satisfy the following requirements to qualify for the IAA

The bank initially rated the exposure at least the equivalent of investment grade
The ABCP program has robust credit and investment guidelines for the exposures underlying the securitization exposure
The ABCP program performs a detailed credit analysis of the sellers of the exposures underlying the securitization exposure
The ABCP programs underwriting policy for the exposures underlying the securitization exposure establishes minimum asset
eligibility criteria that include the prohibition of the purchase of assets that are significantly past due or of assets that are defaulted,
as well as limitations on concentration to individual obligors or geographic areas and the tenor of the assets to be purchased
The aggregate estimate of loss on the exposures underlying the securitization exposure considers all sources of potential risk, such as
credit and dilution risk
Where relevant, the ABCP program incorporates structural features into each purchase of exposures underlying the securitization
exposure to mitigate potential credit deterioration of the underlying exposures

Basel II
Hierarchy of Minimal Capital Requirements Approaches (contd)

Supervisory Formula Approach (SFA)

SFA can be applied to a securitization exposure if the securitization exposure is not a gain-on-sale or a CEIO, does not qualify for
the RBA, and is not an exposure to an ABCP program for which the bank is applying the IAA
A bank qualifies to use the SFA if the bank is able to calculate a set of risk factors relating to the securitization, including the
risk-based capital requirement for the underlying exposures as if they were held directly by the bank
The SFA capital requirement for a securitization exposure depends on the following inputs :

The amount of the underlying exposures

The securitization exposures proportion of the tranche that contains the securitization exposure
The sum of the risk-based capital requirement and expected credit loss (ECL) for the underlying exposures (as determined under the final
rule as if the underlying exposures were held directly on the banks balance sheet) divided by the amount of the underlying exposures (Kirb)
The tranches credit enhancement level
The tranches thickness
The securitizations effective number of underlying exposures
The securitizations exposure weighted average loss given default

A bank must deduct from total capital any part of a securitization exposure that incurs a 1,250% risk weight under the SFA. Any
part of a securitization exposure that incurs less than a 1,250% risk weight must be risk weighted rather than deducted
Under SFA, capital for retained interests and other residual interests is equal to the amount of such exposures if the amount of
such exposure is less than Kirb

Deduction from capital

If a bank is not able to use the above approaches, the bank must deduct the exposure from total capital

Basel II
Exceptions to the General Hierarchy of Approaches

Maximum risk-based capital requirement

General risk-based capital rules

Banks are required to hold a dollar in capital for every dollar in residual interest, regardless of the effective risk-based capital
requirement on the underlying exposures

Double-counting of risks in overlapping of securitization exposures

Unless one or more of the underlying exposures does not meet the definition of a wholesale, retail, securitization, or equity
exposure, the total risk-based capital requirement for all securitization exposures held by a single bank associated with a single
securitization (including any regulatory capital requirement that relates to an early amortization provision, but excluding any
capital requirements that relate to the banks gain-on-sale or CEIOs associated with the securitization) cannot exceed the sum
of (i) the banks total risk-based capital requirement for the underlying exposures as if the bank directly held the underlying
exposures; and (ii) the banks total ECL for the underlying exposures

For banks that have multiple securitization exposures providing duplicative coverage of the underlying exposures of a
securitization (such as when a bank provides a program-wide credit enhancement and multiple pool-specific liquidity facilities
to an ABCP program)
The applicable risk-based capital treatment under the securitization framework that results in the highest capital requirement
is applied to overlapping positions

Other exceptions under original U.S. guidelines

Interest-only mortgage-backed securities must be assigned a risk weight that is no less than 100%
A sponsoring bank that qualifies as a primary beneficiary and must consolidate an ABCP program as a variable interest entity
under GAAP generally may exclude the consolidated ABCP program assets from risk-weighted assets4

A special set of rules applies to transfers of small business loans and leases with recourse by well-capitalized depository
institutions

4 Source:

The bank must hold risk-based capital against any securitization exposures of the bank to the ABCP program

The January 2010 Risk Based Guidelines; Capital Adequacy Guidelines; Capital Maintenance; Regulatory Capital; Impact of Modifications to Generally Accepted Accounting Principles;
Consolidation of Asset-Backed Commercial Paper Programs; and Other Related Issues; Final Rule removed the ABCP exclusion

Dodd-Frank Act
Dodd-Frank Wall Street Reform and Consumer Protection Act
Enacted July 21, 2010, the intention of this act is to promote the financial stability of the
United States by improving accountability and transparency in the financial system, to end
too big to fail, to protect the American taxpayer by ending bailouts, to protect consumers
from abusive financial services practices, and for other purposes
Applicable sections that impact risk-based capital for securitizations

Section 939A Removal of Reliance on Credit Ratings

No later than 1 year after the enactment of this section, each Federal agency shall, to the extent applicable,
review

Any regulation issued that requires the use of an assessment of the credit-worthiness of a security or money market instrument
Any references to or requirements in such regulations regarding credit ratings

Each agency shall modify any such regulations identified by the review to remove any reference to or
requirement of reliance on credit ratings and to substitute in such regulations such standard of creditworthiness as each respective agency shall determine as appropriate for such regulations
Such agencies shall seek to establish, to the extent feasible, uniform standards of credit-worthiness for use
by each agency, taking into account the entities regulated by each agency and the purposes for which such
entities would rely on such standards of credit-worthiness
Notice of Proposed Rulemaking on Section 939A still pending. Expected 1Q12
Market Risk Rules NPR released in December of 2011

Dodd-Frank Act
Dodd-Frank Wall Street Reform and Consumer Protection Act
Applicable sections that impact risk-based capital for securitizations

Section 171 (potentially impacts securitization exposures) Collins Amendment establishes

Collins Amendment final rule was adopted on June 14, 2011. Compliance with capital floor calculated on an
enterprise-wide basis, and floor possibly subject to change with future changes to Basel I rules
Minimum Leverage and Risk-Based Capital Requirements
Investments in Financial Subsidiaries

Section 941

Requires that a securitizer retain an economic interest in a material portion of the credit risk for any asset
that it transfers, sells, or conveys to a third party

Basel II.5
Resecuritizations

Global Resecuritization Definition

Securitization exposure in which the risk to the underlying exposures is tranched and at least
one or more of the underlying exposures is a securitization exposure

ABCP Programs

Assumption: ABCP Conduit does not hold securitization exposures that are resecuritization
exposures:

Deal-specific liquidity facility generally not a resecuritization exposure.

Program-wide credit enhancement (PWCE) that provides protection across pools above seller protection generally would
be a resecuritization exposure.
CP would not be a resecuritization exposures if either:
PWCE was not a resecuritization exposure, or
CP is fully supported by the sponsoring bank.

Basel II.5
Modification of RBA Tables under IRB
Approach

Senior Resecuritization Exposures

Securitization Exposures
Long-term
Rating

Senior position
None of the underlying exposures are
themselves resecuritization exposures.

Resecuritization Exposures

Senior,
Granular

Non-senior,
Granular

Non-granular

Senior

Non-senior

AAA

12

20

20

30

AA

15

25

25

40

A+

10

18

35

35

50

12

20

35

40

65

A-

20

35

35

60

100

BBB+

35

50

50

100

150

BBB

60

75

75

150

225

BBB-

100

100

100

200

350

BB+

250

250

250

300

500

BB

425

425

425

500

650

BB-

650

650

650

750

850

Below

Deduction

Securitization Exposures
Short-term
Rating

Resecuritization Exposures

Senior,
Granular

Non-senior,
Granular

Non-granular

Senior

Non-senior

A1

12

20

20

30

A2

15

25

25

40

A3

10

18

35

35

50

Below

Deduction

Basel II.5
Changes to securitization risk weights under Standardized Approach

Long-term Rating

Securitization Exposures

Resecuritization Exposures

AAA to AA-

20

40

A+ to A-

50

100

BBB+ to BBB-

100

225

BB+ to BB-

350

650

B+ and below or unrated

Short-term Rating

Deduction

Securitization Exposures

Resecuritization Exposures

A-1 / P-1

20

40

A-2 / P-2

50

100

A-3 / P-3

100

225

All other ratings or unrated

Deduction

Basel II.5
Treatment of ABCP liquidity facilities

Standardized Approach

IRB Approach

Credit conversion factor (CCF) for short-term securitization liquidity facilities increased from 20% to 50%.
This means 50% CCF applies to all undrawn ABCP liquidity facilities regardless of the length of commitment
Clarification of When a Liquidity Facility is a Senior Exposure
Senior Liquidity Facility must cover all of the ABCP and other senior debt supported by the pool such that no
cash flows from the underlying pool could be transferred to other creditors until liquidity draws are paid in
full

Market Disruption

Favorable treatment eliminated. The favorable CCFs for market disruption liquidity facilities (0% Standardized Approach / 20% - IRB Approach) have been eliminated

Changes to Market Risk Rules

Basic Principle Capital requirement in respect of a securitization exposure to be calculated by

reference to the risk-weighted exposure amount that would apply if the exposure were held in
the banking book

Basel III
Basel III Overview: A Global Regulatory Framework for More Resilient Banks and Banking Systems

Released in December 2010 with the following objectives:

Improve the banking sectors ability to absorb shocks arising from financial and economic stress, whatever the source, thus
reducing the risk of spillover from the financial sector to the real economy
Improve risk management and governance
Strengthen banks transparency and disclosures

Basel III Implementation Schedule (as currently drafted) 6

2011

Leverage Ratio
C apital C onsevation Buffer
Minimum common equity plus
capital conservation buffer
Phase-in of deductions from
C ET1 (including amounts
exceeding the limit for DTAs,
MSR and financials)
Minimum Tier 1 C apital
Minimum Total C apital
Minimum Total C apital plus
conservation buffer
C apital intstruments that no
longer qualify as non-core Tier 1
capital or Tier 2 capital

Liquidity coverage ratio

Net stable funding ratio

2012

Supervisory
monitoring

2013

2014

2015

2016

Parallel run
1 Jan 2013 - 1 Jan 2017
Disclosure starts 1 Jan 2015
3.5%
4.0%
4.5%
4.5%

2017

2018
Migration
to Pillar I

4.5%

4.5%

4.5%

0.625%

1.25%

1.875%

2.50%

20%

40%

60%

80%

100%

100%

4.5%
8.0%

5.5%
8.0%

6.0%
8.0%

6.0%
8.0%

6.0%
8.0%

6.0%
8.0%

6.0%
8.0%

8.0%

8.0%

8.0%

8.625%

9.25%

9.875%

10.5%

Phased out over 10 year horizon beginning 2013

Observation
period
begins
Observation
period
begins

Source: Basel III: A global regulatory framework for more resilient banks and banking systems

As of
1 January
2019

Introduce
minimum
standard
Introduce
minimum
standard

Basel III
Changes to capital rules affecting securitizations

Tightens definitions qualifying capital

Derecognizes increases in equity capital resulting from a securitization transaction

Securitizations formerly deducted from capital now receive a 1250% risk-weight, which results in increased
capital requirements

Collateral haircut for counterparty exposures

Expected future margin income from a securitization transaction resulting in gain on sale does not count in
the calculation of common equity

1250% risk-weight for certain securitization exposures

Mortgage servicing rights and other similar assets in excess of 15% of common equity must be deducted
from common equity capital. Remainder of these assets risk-weighted at 250%

Exposure haircuts twice as large as haircuts for corporate bonds resecuritizations not eligible collateral

Market Risk

New specific risk haircuts for securitizations and resecuritizations that are higher than similarly rated
government and corporate securities

Basel III
Leverage Ratio

TIER 1 CAPITAL

ASSETS PLUS OFF-BALANCE SHEET EXPOSURES

Common Equity

On-balance sheet assets

Perpetual Preferred Equity

3% of

Stock surplus on Tier 1 eligible shares

Repo and securities lending exposure (no netting)

Derivatives (no netting)

Credit derivatives sold (no netting of purchased protection)

Securitization exposures (per accounting rules)
Off-balance sheet exposures

10% CCF for unconditionally

cancellable commitments
100% CCF for all other commitments

Similar to leverage ratio applicable to U.S. banks

Equity capital must be maintained against unused commitments

Basel III imposes a leverage ratio (essentially a requirement to maintain a specified amount of equity (Tier 1) capital) that is
similar in many respects to the leverage ratio already imposed upon U.S. banks
One major difference, however, is that the current U.S. leverage ratio is a measurement of Tier 1 capital as a percentage of onbalance sheet assets. The Basel III leverage ratio is a measurement of Tier 1 capital to on-balance sheet assets plus off-balance
sheet credit and liquidity commitments
If adopted in its current form, this could greatly increase the cost to banks of providing letters of credit and unfunded
commitments
Unconditionally cancellable commitments are included in the leverage ratio at 10% of their face amount. All other unfunded
commitments are included at 100% of their face amount

No risk adjustment of assets

Assets are not risk-adjusted for purposes of the leverage calculation

Market Risk Risk-Based Capital NPR December 2011

Basic Approach

Introduces a simplified version of the Basel II supervisory formula approach (SSFA)

If a bank cannot, or chooses not to, use the SSFA, securitization position is assigned a risk weighting factor of
100%, which translates to a 1250% risk weight

Required Inputs to Calculate SSFA

Weighted average capital requirement that would be assigned to the underlying exposures under the general riskbased capital rules (Basel I)

Positions level of subordination

Positions relative size within the securitization

Level of losses actually experienced on the underlying exposures

SSFA Designed to Apply Higher Capital to Risky Junior Positions and Lower Capital to Most Senior
Positions

1250% risk weight assigned to positions that absorb losses up to the amount of capital that would be required for
the underlying exposures under the general risk-based capital rules.

For remaining positions, capital decreases as seniority increases, subject to the supervisory floor.

Market Risk Risk-Based Capital NPR December 2011

SSFA Risk Weighting Depends Upon the Following Inputs:

Kg = Weighted average capital requirement of the underlying exposures calculated using the general
risk-based capital rules.

Parameter A (Attachment Point of Position) = Threshold at which credit losses would first be
assigned to the position.
Dollar Amount of Subordinated Positions
Dollar Amount of Asset Pool

Parameter D (Detachment Point of Position) = Threshold at which credit losses would result in a total
loss to the investor in the position.
Value of
Parameter A

Dollar Amount of Position Plus all Pari Passu Positions

+
Dollar Amount of Asset Pool

Supervisory calibration parameter, p = 1.5 for resecuritization positions; 0.5 for other securitization
positions.

Cumulative losses on the underlying asset pool.

Market Risk Risk-Based Capital NPR December 2011

SSFA Formula
KSSFA

ea-u ea-1

Where

______________

a(u-l)

1
P - Kg

u
l
e

=
=
=

D - Kg
A - Kg
2.71828 (base of natural logarithms)

Capital Under SSFA Equals the Greater of:

KSSFA x 100 expressed as a percentage, and

Minimum risk weighting factor that increases over time as cumulative losses increase on the underlying asset pool

Supervisory Minimum Risk-Weighting Factor Floor

Cumulative losses of principal on originally issued

securities as a percent of Kg at origination
Greater than:

Less than or equal to:

Specific risk weighting factor (in percent)

1.6

50

1.6

50

100

8.0

100

150

52.0

150

n/a

100.0

Appendix B: Basel II Timeline

Basel II Timeline: Europe and U.S. transitions to Basel II10

International Transition to Basel II

U.S transition to Basel II

1988

J uly: B asel Co mmittee issues B asel Capital A cco rd (B asel I), internatio nal risk-based
capital requirements fo r banks in G10 co untries, to be fully implemented by 1992.

1989
1990
1991
1992
1993

1994
1995
J a nua ry: B asel Co mmittee amends B asel I to inco rpo rate market risks. The M arket Risk
A mendment intro duces the use o f institutio ns' internal mo dels o f risk to determine
regulato ry capital requirements.

J une : B asel Co mmittee pro po ses fo r co mment incremental revisio ns to B asel I fo r credit
risk (standardized appro ach), plans to develo p an alternative internal ratins-based (IRB )
appro ach, and the pro po sed capital charges fo r o ther majo r risks, including o peratio nal risk.

1996
1997
1998
1999
2000

2001
J a nua ry: B asel Co mmittee releases revised pro po sal based o n co nsultatio n with industry
and superviso rs. The Co mmittee aims to enco urage impro ved risk management practices in
part thro ugh capital incentives fo r banks to mo ve to the mo re risk-sensitive IRB appro ach.

2002
2003
2004

A pril- M a y: B asel Co mmittee releases results o f a glo bal quantitative impact study (QIS-3)
and issues third co nsecutive paper fo r co mment.
J une : B asel Co mmittee issues final revised framewo rk fo r B asel II (New B asel A cco rd). It
reiterates o bjectives o f bro adly maintaining the level o f aggregate required capital while also
pro viding incentives to ado pt the mo re advanced appro aches. The framewo rk includes
changes such as a 1.06 scaling facto r by which capital requirements fo r credit risk wo uld be
multiplied in o rder to maintain capital neutrality with previo usly estimated results.

2005

B ank regulato rs - OCC, OTS, Federal Reserve, and FDIC (hereafter "regulato rs") - implement
B asel I with a transitio n perio d to 1992.
Regulato rs fully phase in B asel I as part o f bro ader changes to capital regulatio n. The pro mpt
co rrective actio n pro visio ns o f FDICIA require adequately capitalized and well-capitalized
institutio ns to meet o r exceed B asel I risk-based capital requirements as well as a leverage
requirement.
S e pt e m be r: OCC, Federal Reserve, and FDIC issue final rule implementing the M arket
Risk A mendment, requiring institutio ns with significant trading activity to use internal mo dels
to measure and ho ld capital in suppo rt o f market risk expo sure.
A ugus t : Regulato rs release advance NP R o n B asel II fo r co mment. The pro po sed rule
requires the advanced appro aches fo r credit and o peratio nal risk to be applied by o nly the
large and/o r internatio nally active banks and ho lding co mpanies. Existing capital rules wo uld
be retained fo r all o ther banks.
J une : SEC releases alternative net capital rule the permits certain bro ker-dealers to use
internal mathematical mo dels to calculate market and derivatives-related credit risk. To apply
the rule, a bro ker-dealer's ultimate ho lding co mpany must co nsent to gro up-wide supervisio n
and repo rt capital adequacy measures co nsistent with B asel standards.
J a nua ry: Regulato rs issue interagency statement o n qualificatio n pro cess fo r advanced
appro aches based o n New B asel A cco rd.
A pril: Regulato rs anno unce delay in B asel II rulemaking pro cess, after results o f a
quantitative impact study (QIS-4) estimated material reductio ns in aggregate capital
requirements and significant variatio ns in results acro ss institutio ns and po rtfo lio s.
Regulato rs later state that such results wo uld be unacceptable in an actual capital regime.
S e pt e m be r: Regulato rs anno unce 1-year delay in implementatio n and additio nal
safeguards to prevent unacceptable declines in required capital as estimated in QIS-4. The
agencies retain the leverage requirement, add a transitio n year, and establish stricter
transitio n perio d limits o n capital reductio ns fo r individual institutio ns.
O c t o be r: Regulato rs issue B asel IA advance NP R. It revises B asel I to address
co mpetitive inequities between large and small institutio ns by pro viding a mo re risk-sensitive
framewo rk similar to the standardized appro ach under the B asel II internatio nal acco rd.

10

Source: GAO for portions of the timeline.

Appendix B: Basel II Timeline (contd)

Basel II Timeline: Europe and U.S. transitions to Basel II10

International Transition to Basel II

U.S transition to Basel II

J une : B asel Co mmittee releases results o f a glo bal quantitative impact study (QIS-5) o f
estimated changes in minimum required capital under B asel II.

M a rc h: Federal Reserve releases draft B asel II NP R to allo w industry time to co mment and
prepare. In additio n to previo usly anno unced safeguards, it states that agencies wo uld view a
10% o r greater decline in aggregate risk-based capital requirements (co mpared to B asel I) as
a material dro p warranting changes to the B asel II framewo rk.

2006
J une : EU issues final rule implementing B asel II (EU Capital Directive.)

2007

2008
J uly : B asel II enhancements

2009

2010
D e c e m be r: B asel II

D e c e m be r: US M arket Risk NP R

2011

S e pt e m be r: Regulato rs release fo r co mment o fficial NP Rs fo r B asel II and fo r market risk.

The B asel II NP R appro ach sho uld be pro vided to banks as an o ptio n in additio n to the
advanced appro ach fo r credit risk.
D e c e m be r: Regulato rs release NP R fo r B asel IA .
F e brua ry: Regulato rs issue pro po sed guidance fo r advanced appro aches and superviso ry
review.
M a rc h: Co mment perio ds fo r B asel II and B asel IA NP Rs clo se.
J uly: Regulato rs agree to issue advanced appro aches rule mo re co nsistent with New B asel
A cco rd and to issue an NP R fo r an o ptio nal standardized appro ach.
D e c e m be r: Regulato rs issue advanced appro aches rule.
J uly: Regulato rs issue NP R fo r o ptio nal standardized appro ach co ntaining questio n o n
whether co re banks sho uld be able to cho o se this appro ach. Regulato rs issue updated
guidance fo r superviso ry review.
O c t o be r: Last date fo r co re banks to ado pt implementatio n plan signed by bo ard o f
directo rs.
J a nua ry: The agencies release "Risk-B ased Capital Guidelines; Capital M aintenance:
Regulato ry Capital; Impact o f M o dificatio ns to Generally A ccepted A cco unting P rinciples;
Co nso lidatio n o f A sset B acked Co mmercial P aper P ro grams; and Other Related Issues"
J uly : Do dd-Frank A ct
A ugus t : Sectio n 939a A NP R

10

Source: GAO for portions of the timeline.

Speakers

Bill Falcon, Vice President, PNC, Pennsylvania

Tim Mohan, Chief Executive Partner, Chapman and Cutler LLP, Illinois