Standardised approach to credit risk under Basel II

[Imad]

Hi David,

If a bank retains the equity tranche of a securitization where the notional of the tranche is $10 mio and the tranche has a long term B- credit rating, what is the capital charge under the SA for securitization exposures?

a- $400,000
b- $800,000
c- $1.2 mio
d- $10 mio

Your answer was $10 mio: B+ and below rated securitizations are DEDUCTED while implies risk weight such that CRC = $10 mio * 12.8 * 8% = $10 mio.

My argument: As per Basel, only unrated assets will be subject to deduction. Since the tranche is rated B-, a RWA of 150% should apply....please verify!

Thanks
Imad

 

[David Harper CFA FRM]

Hi Imad,

Your argument works for non-securitized credit assets. It is easy to miss/forget but the Basel Standardized Approach rating/type matrix is only in reference to "Rules for corporate, sovereign, and bank exposures" (from the Basel document). So, your RWA of 150% for B- applies to:

• Sovereign exposures,
• Bank (debt, loans), or
• Corporate exposures

But securitization exposures (e.g., retained tranches in a securitzation) are given their own matrix, which is basically the same as the SA Bank RWAs matrix for investment grade securitization exposures (to BBB-) but for speculative ratings (BB+ and lower) has (much) higher weights thank bank exposures, as we might expect, thanks,

 

[Imad]

Hi David,

Thanks for your reply, however, Schweser book says: The standardized approach to estimating securitization exposures treats assets rated Baa3 or better similar to other credit riks. Riskier assets have higher risk weights applied, and if an asset has no external rating, then there is a direct deduction to capital (half to core capital and half to additional capital).

Thanks

 

[David Harper CFA FRM]

Hi Imad,

Here is the risk weight table under SA for securitization exposures (see para 567 of the basel II framework at https://www.bis.org/publ/bcbs107.htm).

Please note that, for long term securitizations, a deduction applies to (i.e., 1250% weight) applies to B+ or below or unrated:

 

[sasasbn]

Do we need to memorize this tables?

 

[ShaktiRathore]

hi
I dont know about David,but As far as i know u dont need to memorise such tables. But just get an idea of what is what like risk weight is higher for BBB than AA etc.
thanks

 

[David Harper CFA FRM]

I agree with ShaktiRathore that memorization of this table is unnecessary. In general, FRM questions are often difficult not due to GARP asking for minutia (they are not cruel that way), but rather because they ask about the concept in an unexpected way. The above sort of memorization is precisely what the FRM tends to avoid. Thanks,