Basel's proposed restrictions on internal models for credit risk

Overview

Last week, the Basel Committee on Banking Supervision (Basel) proposed floors and other constraints on the use of internal models for calculating credit risk capital. The proposal aims to reduce complexity and model-driven variation in the calculation of regulatory capital among banking institutions, thus improving comparability. To that end, the proposal generally discourages (and in some instances prohibits) the use of internal ratings-based (IRB) approaches in calculating risk weighted assets related to credit risk.

1. US implementation of the Basel proposal is unlikely to be a priority.
2. Basel’s risk-based capital floors narrow non-US banks' advantage.
3. The Basel proposal prohibits the use of IRB approaches for certain loan portfolios.
4. The proposal further limits banks’ use of IRB approaches by introducing floors for model inputs.
5. Refinements to "Downturn LGD" will increase regulatory capital under IRB approaches.