Regulatory Alerts2013-12-11 | BSD/DIR/CIR/GEN/LAB/06/053/3Guidance Notes on the Calculation of Capital Requirement for Credit Risk: Standardized Approach
The ECB has released a consultation paper proposing new rules for calculating the capital requirements of banks and other financial institutions. The proposals are based on the Comprehensive Method, which is currently used by some large banks. Under these proposed changes, credit protection provided in forms such as guarantees and credit derivatives will be valued more conservatively than under existing rules. This means that the value of this type of protection, particularly for smaller banks, may be significantly reduced. The new rules will also include a new risk-mitigating measure called Netting for On-Balance Sheet Items. This will allow banks to net off their exposures and liabilities in a consolidated manner, which could result in a more accurate reflection of their true capital requirements. Other significant changes proposed include: 1. Tighter haircuts on collateral: Haircuts are the percentage reductions applied to the market value of collateral to account for its riskiness. The new rules propose tighter haircuts, meaning that banks will have to hold more capital against their assets. 2. Valuation of currency mismatches: The proposals include a requirement to adjust the value of credit protection provided in currencies other than the one in which the underlying exposure is denominated. This is to account for foreign exchange risk. 3. Adjustment for maturity mismatches: If there is a significant difference between the maturities of the credit protection and the underlying exposure, an adjustment will be applied to the value of the credit protection. This is intended to mitigate the risk of such differences in practice. In summary, under these proposed changes, banks and other financial institutions would need to hold more capital against their assets. Additionally, banks and other financial institutions would need to make more conservative valuations for certain types of credit protection."