Implementation Of The Basel III Final Reform Package
Consultation paper CP 20.02November 2020Implementation ofthe Basel III FinalReform Package104
ContentsIINTRODUCTION. 11Overview. 12Structure of this Consultation Paper . 4IILOCAL QIS. 5IIIREVISED STANDARDISED APPROACH FOR CREDIT RISK . 71Introduction / overview . 72Proposed modifications to risk-weighting methodology . 72.1 Exposures to sovereign, non-central government public sector entities and multilateraldevelopment banks . 82.2Exposures to banks. 92.3Exposures to covered bonds . 102.4Exposures to securities firms and other financial institutions . 102.5Exposures to corporates . 112.6Subordinated debt, equity and other capital instruments . 122.7Retail exposures . 142.8Real estate exposure class . 142.9Off-balance sheet items . 192.10 Defaulted exposures . 193Qualitative requirements in relation to the use of risk-weights based on externalratings . 204Credit risk mitigation . 21IVREVISED BASIC APPROACH FOR CREDIT RISK . 221Introduction / overview . 222Proposed modifications to risk-weighting methodology . 222.1Exposures to multilateral entities other than multilateral development banks . 222.2Exposures to covered bonds . 222.3Exposures to RMLs . 232.4Land acquisition, development and construction exposures . 242.5Equities and subordinated debts . 25
2.6Capital instruments and non-capital LAC liabilities of financial sector entities. 252.7Holdings of shares in commercial entities . 263Proposed modifications to methodology for calculating exposure amount of offbalance sheet items. 264Proposed modifications to credit risk mitigation framework . 264.1Eligible credit risk mitigation techniques . 264.2Minimum haircut floors for SFTs. 26VREVISED INTERNAL RATINGS-BASED APPROACH FOR CREDIT RISK . 291Introduction / overview . 292General approach and presumptions . 293Specific proposals . 313.1Migration of specified asset portfolios . 313.2Treatment of maturity under the foundation IRB approach . 333.3Exemption from definition of commitments . 333.4Residential mortgages. 333.5Sovereign exposures . 343.6Adoption of IRB approach for asset classes . 344Preliminary Implementation Arrangements . 36VIREVISED OPERATIONAL RISK FRAMEWORK . 381Introduction . 382Proposed modifications to operational risk framework. 382.1Calculation of minimum operational risk capital . 382.2Exclusions in the calculation of business indicator and historical losses. 403Proposed approach for local implementation . 41VIIOUTPUT FLOOR. 44VIIIREVISIONS TO THE LEVERAGE RATIO STANDARD . 451Introduction . 452Proposed revisions . 452.1Measurement of derivative exposures . 452.2Revisions to the specific treatment for written credit derivatives . 46
2.3Treatment of regular-way purchases and sales of financial assets . 472.4CCFs for off-balance sheet items . 472.5Exemption of central bank reserves . 482.6LR buffer for G-SIBs . 48IXIMPLEMENTATION TIMELINE . 49
IINTRODUCTION1Overview1The Basel III reforms are the Basel Committee on Banking Supervision (“BCBS”)’s keyresponse to the global financial crisis. Their aim is to address the shortcomings ofthe pre-crisis regulatory framework including, among others, insufficient high-qualitycapital, excessive and pro-cyclical build-up of leverage, imprudent liquiditymanagement, high concentration of exposures, as well as “Too Big to Fail” of globalsystemically important banks (“G-SIBs”).2In terms of regulatory capital requirement, the Basel III reforms started off with thepublication in December 2010 (subsequently revised in June 2011) “Basel III: A globalregulatory framework for more resilient banks and banking systems”1 (“June 2011Basel document”) to, inter alia, (i) raise the quality, consistency and transparency ofthe capital base, (ii) enhance risk coverage, (iii) supplement the risk-based capitalrequirement with a leverage ratio, (iv) reduce pro-cyclicality and promotecountercyclical buffers, and (v) address systemic risk and interconnectedness. Thestandards set out in the June 2011 Basel document have already been incorporated inour local legislations.3On 7 December 2017, the BCBS issued the document “Basel III: Finalising post-crisisreforms” 2 (“Basel III final reform package”). A key objective of the Basel III finalreform package is to reduce excessive variability of risk-weighted assets which mightaffect the credibility and comparability of the reported risk-weighted capital ratiosamong banks.4In summary, the Basel III final reform package introduced the following revisions tothe existing capital framework:(i)Credit risk - standardised approach: (1) improve granularity and risk sensitivitycalibration of credit exposures and (2) reduce excessive reliance on externalcredit rating, with a more granular approach for unrated exposures;(ii)Credit risk - internal ratings-based approach (“IRB approach”): (1) constrain theuse of internal models where appropriate (e.g. due to insufficient data tomodel portfolios with low-default history); (2) impose minimum floor values1Please refer to https://www.bis.org/publ/bcbs189.pdf.2Please refer to https://www.bis.org/bcbs/publ/d424.pdf.1
for bank estimates; and (3) specify more refined requirements on estimationpractice of banks;(iii)Credit valuation adjustment (“CVA”) framework: remove the internallymodelled approach and introduce a revised standardised approach;(iv)Operational risk: replace the existing internal model based approach (currentlynot adopted in Hong Kong) and two standardised approaches by a single nonmodel based revised standardised approach with parameters more indicativeof operational risk;(v)Output floor: introduce a revised standardised approach-based output floor tolimit capital benefits from the use of internal models (relative to usingstandardised approaches only); and(vi)Leverage ratio: introduce some revisions to the leverage ratio framework, viz.,a new leverage ratio buffer for GSIBs and a few technical adjustments to theoriginal text.5Closely associated with the Basel III final reform package is the revised market riskframework which addresses outstanding structural shortcomings in the existingframework. The main changes include (1) further specifications for the scope ofapplication designed to reduce incentives for regulatory arbitrage between thetrading book and the banking book; (2) a revision of the Internal Models Approach(“IMA”) to better capture tail risks and market illiquidity risks; and (3) the introductionof a new standardised approach that is more risk-sensitive to serve as a crediblefallback to the IMA.6According to the original BCBS timetable, the above revised standards will take effectfrom 1 January 2022 with a phase-in period of 5 years. However, in order to provideadditional operational capacity for banks and supervisors to respond to the immediatefinancial stability priorities resulting from the impact of the coronavirus disease on theglobal banking system, the implementation will be deferred by one year to start from1 January 20233, with the output floor to be phased in over 5 years as follows:3Please refer to https://www.bis.org/press/p200327.htm.2
Date7Output floor 41 January 202350%1 January 202455%1 January 202560%1 January 202665%1 January 202770%1 January 202872.5%For the revised market risk framework, locally incorporated authorized institutions(“AIs”) will be required to implement it for reporting purposes by 1 January 2023.The local implementation of the actual capital requirements based on the newframework will be no earlier than 1 January 2023. Its timing will take into accountthe implementation progress observed in major jurisdictions.The localimplementation timeline of the revised CVA framework will be aligned with that of therevised market risk framework in terms of reporting and actual capital requirements.8The aim of this consultation paper (“CP”) is to consult the industry on the proposedapproach of the Hong Kong Monetary Authority (“HKMA”) to implementing the BaselIII final reform package in respect of standards included in the package, other thanthose in relation to the revised market risk framework and the revised CVA frameworkwhich, together with other standards (such as the disclosure requirements associatedwith the package), have been / will be the subject(s) of separate consultation(s) 5 .The policy proposals contained in this CP have taken into consideration the outcomeof a quantitative impact study (“QIS”) on selected locally incorporated AIs.9The consultation will close on 6 January 2021.4At national discretion, supervisors may cap the increase in a bank’s total risk-weighted assets thatresults from the application of the output floor during its phase-in period at 25% of a bank’s internallycalculated risk-weighted assets before the application of the floor.5The HKMA issued a consultation paper sets out its proposal for the revised market risk framework regulator y resources/consultations/CP19 01 Market Risk.pdf).3
2Structure of this Consultation Paper10Part II of this CP sets out the overall results of the local QIS referred to in paragraph 8.Where appropriate, the HKMA has taken into account the results in the policyproposals in respect of standards included in the Basel III final reform package as setout in Part III to Part VIII of this CP:(i)Part III – the revised standardised approach for credit risk;(ii)Part IV – a revised basic approach for credit risk (retained from the currentframework incorporating certain modifications to align with the revisedstandardised approach for credit risk, which are retained for use by the currentusers of the basic approach);11(iii)Part V – the revised internal ratings-based approach for credit risk;(iv)Part VI – the revised operational risk framework;(v)Part VII – the output floor; and(vi)Part VIII – the revisions to the leverage ratio standard.Finally, Part IX sets out the proposed work plan (with timeline) for implementing theBasel III final reform package in Hong Kong.4
IILOCAL QIS12To inform policy formulation, the HKMA conducted in 2019 a local QIS on 21 locallyincorporated AIs (consisting of 13 standardized (credit risk) approach (“STC”), 5foundation IRB approach (“FIRB approach”) and 3 advanced IRB approach (“AIRBapproach”) users) to gauge the impact of the Basel III final reform package on AIs inrespect of credit risk and operational risk. The results, which varied for AIs usingdifferent approaches, are summarised in the chart below.%Actual24Total CAR22.721.92220Basel III final package20.319.8 19.919.618.617.7181614All AIs13Advanced IRB(AIRB) AIsFoundation IRB(FIRB) AIsSTC AIsFor the 13 STC AIs, they generally reported a better capital position under the Basel IIIfinal reform package, with an increase of total capital adequacy ratio (“CAR”) of 0.76percentage points on average. Detailed breakdown shows that this mainly comesfrom decreases in risk-weighted amounts (“RWAs”) for bank exposures, residentialmortgage loans (“RMLs”) and commercial real estate exposures 6. In fact, amid theincrease in granularity and risk sensitivity, the revised standardised approach forcredit risk is somehow looser than our existing rules on some key asset classes. Hence,in order to uphold our prudential standard, our policy direction is to adopt a relativelymore conservative stance in a couple of areas (such as those in relation to the riskweight calibration and national discretions for RMLs).6The decreases in RWAs in these portfolios are mainly due to more relaxed risk-weight calibrations.5
14For the three AIs using the AIRB approach, QIS results show that total CAR decreasedby 0.88 percentage points on average, mainly because of the operation of the outputfloor and the mandatory migration of bank exposures from the AIRB approach to theFIRB approach. Thus, the policy direction is to provide flexibility (to the extentallowed under the revised IRB approach and our local rules) for such AIs to alleviatetheir adjustment burdens.15For the 5 FIRB AIs, they reported a better capital position under the Basel III finalreform package (increase of average total CAR by 0.82 percentage points), partly dueto the relaxation of some FIRB specific requirements 7 . Thus, in consideration ofproviding more flexibility for AIRB AIs, it needs to be balanced against the impact onFIRB AIs in order to avoid unintended excessive capital release if such flexibility alsoapplies to FIRB AIs.7For instance, the reduction of the supervisory loss given default (“LGD”) for unsecured exposures tocorporates that are not financial institutions from 45% to 40% (which in effect translates into an 11%reduction in IRB RWA).6
III REVISED STANDARDISED APPROACH FORCREDIT RISK1Introduction / overview16The Basel III final reform package retained with revisions the external ratings-basedstandardised approach for credit risk (“SACR”) and the IRB approach for thecalculation of capital requirement of a bank’s credit (i.e. non-securitisation) riskexposures. This part highlights the key revisions to the existing SACR and the HKMA’sproposed approach to implementing them. Proposals in relation to the revised IRBapproach, including the migration of certain portfolios to the revised SACR asmandated by the Basel III final reform package, will be the subject of Part V. Thebasic approach (“BSC”) under the existing local framework is also proposed to beretained with certain modifications, which will be discussed in Part IV.17The revised SACR includes different sets of risk-weighting requirements for certainportfolios, respectively to cater for jurisdictions that allow the use of external ratingsfor regulatory purposes and those that do not.For banks incorporated injurisdictions that allow the use of external ratings for regulatory purposes (includingHong Kong), due diligence is necessary to assess whether the risk-weight applied isappropriate and prudent8.18In this part, for the sake of clarity, “existing SACR” and “revised SACR” refer to thestandardised approach for credit risk as set out in the Basel capital framework beforeand after the revisions pursuant to the Basel III final reform package; whereas “existingSTC” and “revised STC” refer to the standardised approach for credit risk asimplemented currently and in future (i.e. to reflect the revised SACR) under theBanking (Capital) Rules (“BCR”).2Proposed modifications to risk-weighting methodology19Apart from certain areas, the portfolio classification and the risk-weightingmethodology under the revised SACR generally follow those of the existing SACR,albeit with some modifications. The following highlights, for each portfolio and maincomponent of the revised SACR, the key modifications over the existing SACR and ourproposed approach to implementing them.As in the case of the existing SACR, there8This requirement does not apply to exposures to sovereigns and non-central government publicsector entities – see CRE20.4 to CRE20.6 of the 2022 version of the consolidated Basel Framework(https://www.bis.org/basel framework/chapter/CRE/20.htm?inforce 20220101 ).7
are areas of national discretion under the revised SACR. For the purpose of this CP,the general presumption is that any area of national discretion brought forward fromthe existing SACR will continue to be exercised in the current manner, and thefollowing content will only focus on those areas that are newly i
III final reform package in respect of standards included in the package, other than those in relation to the revised market risk framework and the revised CVA framework which, together with other standards (such as the disclosure requirements associated with the package), have been / will be the subject(s) of separate consultation(s)5.
May 02, 2018 · D. Program Evaluation ͟The organization has provided a description of the framework for how each program will be evaluated. The framework should include all the elements below: ͟The evaluation methods are cost-effective for the organization ͟Quantitative and qualitative data is being collected (at Basics tier, data collection must have begun)
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The Basel III international regulatory framework, which was produced in 2010 by the Basel . Highlights of the Final Rule Implementing Basel III and Various Dodd-Frank . 0129_capital_primer_elliott.pdf. 8 The name, Basel Accord, comes from Basel, Switzerland, the home of the Bank for International Settlements (BIS).
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