Credit Risk – Standardised Approach

As part of its near-final rules (PS9/24) the PRA has proposed several changes to the Standardised Approach for credit risk which could have a significant impact on the RWAs for UK banks and building societies.

These changes have been designed to address over-reliance on external credit ratings, increase risk sensitivity and promote effective competition between SA and IRB firms. This includes additional exposure sub-classes; a grading mechanism for unrated corporates; due diligence requirements on the use of external credit ratings; removal of the small and medium-sized enterprise (SME) support factor and reclassification of real estate exposure risk weights.

Reclassification of Retail and Commercial Mortgages

Under the new rules, the regulatory real estate exposure risk weights will be determined based on the type of property, the loan-to-value (LTV) ratio and whether repayments are ‘materially dependent on the cash flows generated by the property’.

The proposals relating to care homes, purpose-built student accommodation and holiday lets represent a compromise from the PRA. In a major revision from the consultation stage, these categories of lending will not be entirely excluded from the residential property category. However, the litmus test of whether these types of property will receive lower risk weights, is if they can be resold as a standard residential dwelling.

Significant amendments have been made to how firms are permitted to carry out valuation of real estate collateral. While the valuation of collateral will still take place at origination, a revaluation backstop has been put in place. This will mean firms will have to acquire an updated valuation every 5 years, with exceptions for larger exposures and in instances when the market is experiencing significant stress.

What banks should consider:

There are likely to be material impacts on disclosures due the increased risk-sensitivity of weightings and the additional reporting templates affecting how data is presented to the regulator. Firms will need to ensure that collected data is accurate, consistent, and compliant across different systems and sources. To achieve this firms may need to seek external assurance.
Firms will need to perform a gap analysis to understand the implications of the changes in the underlying risk weight calculations and impact this will have on their Pillar 1 requirements.
Firms with large exposures to the care-home, holiday lets and student accommodation sectors will need to develop a clear documented policy on their approach to defining what is a ‘standard residential dwelling’. This will then determine what exposures fall under the beneficial regulatory real estate exposure class.

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Basel 3.1 - Bitesize

In this series of short bitesize articles, our Prudential Regulation Consulting team delves into the implications of Basel 3.1 changes on banks.

Operational Risk

Under Basel 3.1, all existing Pillar 1 operational risk approaches (basic indicator approach, standardised and advanced measurement) are being replaced by a new standardised approach which aims to encompass a firm’s size, complexity and historic operational risk performance. the latter is dictated by the internal loss multiplier (ILM) calculation.