UK Basel 3.1 standards: Credit risk standardised approach – exposures to corporates
On 30 November 2022, the Prudential Regulation Authority (PRA) published a Consultation Paper 16/22 (CP16/22) proposing the implementation of Basel 3.1 standards. The framework was originally proposed to be implemented on January 1, 2025. However, according to the news release dated September 27, 2023, the revised implementation date is July 1, 2025. A brief summary of the changes proposed to ‘corporate exposures’ under the credit risk standardised approach is provided below.
Key changes to exposures to corporates (Article 122), under the standardised approach, include:
Infrastructure and Small- and Medium-sized Enterprise (SME) support factors are proposed to be removed. To replace the SME support factor, a reduced risk weight of 85% has been proposed for unrated SMEs.
The annual turnover threshold has been updated from EUR 50 million to GBP 44 million for SME classification.
A reduced risk weight of 75% (currently 100%) has been proposed for Credit Quality Step (CQS) 3 rated corporates.
Due diligence^ requirement added to ensure external rating prudently reflects the creditworthiness of the corporates, if not, at least one step higher risk weight is to be applied.
A new more risk-sensitive approach^^ has been introduced to assign risk weight for unrated exposures to corporates. Prior permission from the PRA is required to use this new approach.
A new approach has been introduced to determine risk weights for issue-specific unrated specialised lending exposures within the 'exposures to corporates'. Specialised lending exposures are to be further bifurcated into object finance, commodities finance or project finance. The risk weight impact for specialised lending is not included in this article and is provided separately.
A summary of the proposed classifications and applicable risk weights is given below:
Existing and proposed Risk Weights
^ External credit ratings and due diligence: (only applicable to exposures to corporates, institutions, and covered bonds)
Due diligence requirements include:
Monitoring counterparties
Adequate understanding of risk profiles
Group structure and analysis of counterparty where the exposure is held
Due diligence to happen at the inception and at least annually thereafter
Regular access to information to perform the due diligence
The due diligence process should be adequate for the size and complexity of the firm
The requirement to increase risk weights
An assessment is to be made using due diligence to ensure that the risk weight applied is appropriate and prudent
In the event the due diligence indicates higher risk than the risk weight assigned using external rating, the firm is to assign the risk weight of at least one step higher CQS.
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^^ Approaches for unrated exposures to corporates:
Approach 1: A risk-neutral approach of a 100% risk weight where:
the risk-sensitive approach is too costly or complex for a firm, or
the firm does not have the capability to robustly assess the risk.
Approach 2: A risk-sensitive approach that would be available where a firm has sound, effective and comprehensive strategies, systems and due diligence processes to accurately assess the risk of unrated corporate exposures.
Unrated exposure would be classified between ‘investment grade’ (IG) and ‘non-investment grade’ (Non-IG) based on the internal credit rating system
IG exposures would be risk-weighted at 65%, while Non-IG at 135%.