Office of the Superintendent of Financial Institutions
The Capital Adequacy Requirements (CAR) for banks (including federal credit unions), bank holding companies, federally regulated trust companies, federally regulated loan companies and cooperative retail associations are set out in nine chapters, each of which has been issued as a separate document. This document, Chapter 3 – Credit Risk – Standardized Approach, should be read in conjunction with the other CAR chapters which include:
This chapter is drawn from the Basel Committee on Banking Supervision’s (BCBS) Basel II and III frameworks, International Convergence of Capital Measurement and Capital Standards – June 2006 and Basel III: A global regulatory framework for more resilient banks and banking systems – December 2010 (rev June 2011). For reference, the Basel II text paragraph numbers that are associated with the text appearing in this chapter are indicated in square brackets at the end of each paragraphFootnote 2.
Note that all exposures subject to the standardized approach should be risk-weighted net of specific allowancesFootnote 3.
The risk weight categories apply to on-balance sheet and off-balance sheet credit equivalent amounts with the exception of items that are deducted from capital as regulatory adjustments pursuant to section 2.3 of Chapter 2 – Definition of Capital.
Claims on sovereigns and their central banks are risk weighted as follows:
[BCBS June 2006 par 53]
National supervisors may allow a lower risk weight to be applied to banks’ exposures to their sovereign (or central bank) of incorporation denominated in domestic currency and funded Footnote 5 in that currency.Footnote 6 Institutions operating in Canada that have exposures to sovereigns meeting the above criteria may use the preferential risk weight assigned to those sovereigns by their national supervisors. [BCBS June 2006 par 54]
For claims on sovereigns that are unrated, institutions may use country risk scores assigned by Export Credit Agencies (ECAs). Consensus risk scores assigned by ECAs participating in the “Arrangement on Officially Supported Export Credits” and available on the OECD websiteFootnote 7, correspond to risk weights as follows:
[BCBS June 2006 par 55]
Claims on the Bank for International Settlements, the International Monetary Fund, the European Central Bank, the European Community, European Stability Mechanism and the European Financial Stability Facility receive a 0% risk weight. [BCBS June 2006 par 56, BCBS nl17Footnote 8, March 2014)]
PSEs are defined as:
entities directly and wholly-owned by a government,
school boards, hospitals, universities and social service programs that receive regular government financial support, and
[BCBS June 2006 par 58]
Claims on PSEs receive a risk weight that is one category higher than the sovereign risk weight:
[BCBS June 2006 par 57]
There are two exceptions to the above:
Claims on the following entities will receive the same risk weight as the Government of Canada:
All provincial and territorial governments and agents of the federal, provincial or territorial government whose debts are, by virtue of their enabling legislation, obligations of the parent government
Claims on the following entities will be treated like claims on corporates:
Entities that are, in the judgement of the host government, significantly in competition with the private sector. Institutions should look to the host government to confirm whether an entity is a PSE in competition with the private sector.
The PSE risk weight is meant for the financing of the PSE’s own municipal and public services. Where PSEs other than Canadian provincial or territorial governments provide guarantees or other support arrangements other than in respect of the financing of their own municipal or public services, the PSE risk weight may not be used.
PSEs in foreign jurisdictions should be given the same capital treatment as that applied by the national supervisor in the jurisdiction of origin.
Claims on MDBs that meet the following criteria receive a risk weight of 0%:
very high quality long-term issuer ratings, i.e. a majority of an MDB’s external assessments must be AAA,
shareholder structure is comprised of a significant proportion of sovereigns with long-term issuer credit assessments of AA- or better, or the majority of the MDB’s fund-raising is in the form of paid-in equity/capital and there is little or no leverage,
strong shareholder support demonstrated by the amount of paid-in capital contributed by the shareholders; the amount of further capital the MDBs have the right to call, if required, to repay their liabilities; and continued capital contributions and new pledges from sovereign shareholders,
adequate level of capital and liquidity (a case-by-case approach is necessary in order to assess whether each MDB’s capital and liquidity are adequate), and
strict statutory lending requirements and conservative financial policies, which would include among other conditions a structured approval process, internal creditworthiness and risk concentration limits (per country, sector, and individual exposure and credit category), large exposures approval by the board or a committee of the board, fixed repayment schedules, effective monitoring of use of proceeds, status review process, and rigorous assessment of risk and provisioning to loan loss reserve.
[BCBS June 2006 par 59]
MDBs currently eligible for 0% risk weight are:
[BCBS June 2006 par 59, BCBS nl19, Nov 2016Footnote 9)]
Otherwise, the following risk weights apply:
Canadian deposit taking institutions (DTIs) include federally and provincially regulated institutions that take deposits and lend money. These include banks, trust or loan companies and co-operative credit societies.
The term bank refers to those institutions that are regarded as banks in the countries in which they are incorporated and supervised by the appropriate banking supervisory or monetary authority. In general, banks will engage in the business of banking and have the power to accept deposits in the regular course of business.
For banks incorporated in countries other than Canada, the definition of bank will be that used in the capital adequacy regulations of the host jurisdiction.
The risk weight applied to a claim on a bank is dependent on the credit assessment of the sovereign in the bank’s country of incorporation. The bank risk weight is one notch less favourable than that which applies to its sovereign of incorporation. The following risk weights apply to claims on DTIs and banks:
[BCBS June 2006 par 63]
Claims on parents of DTIs that are non-financial institutions are treated as corporate exposures.
Claims on securities firms may be treated as claims on banks provided these firms are subject to supervisory and regulatory arrangements comparable to those under Basel II framework (including, in particular, risk-based capital requirements).Footnote 10 Otherwise, such claims would follow the rules for claims on corporates. [BCBS June 2006 par 65]
The table provided below illustrates the risk weighting of rated corporate claims, including claims on insurance companies. The standard risk weight for unrated claims on corporates will be 100%. No claim on an unrated corporate may be given a risk weight preferential to that assigned to its sovereign of incorporation.
[BCBS June 2006 par 66]
Retail claims are risk-weighted at 75%. [BCBS June 2006 par 69]
To be included in the regulatory retail portfolio, claims must meet the following four criteria:
the exposure is to an individual person or persons or to a small business.
the exposure takes the form of any of the following: revolving credits and lines of credit (including credit cards and overdrafts), personal term loans and leases (e.g. instalment loans, auto loans and leases, student and educational loans, personal finance) and small business facilities and commitments. Securities (such as bonds and equities), whether listed or not, are specifically excluded from this category. Mortgage loans are excluded to the extent that they qualify for treatment as claims secured by residential property.
the supervisor must be satisfied that the regulatory retail portfolio is sufficiently diversified to a degree that reduces the risks in the portfolio, warranting the 75% risk weight.
the maximum aggregated retail exposure to one counterpart cannot exceed an absolute threshold of CAD $1.25 million. Small business loans extended through or guaranteed by an individual are subject to the same exposure threshold.
[BCBS June 2006 par 70]
Residential construction loans meeting the above criteria are risk-weighted at 75%. Residential construction loans that do not meet the above criteria must be treated as a corporate exposure subject to the risk weights in section 3.1.7.
Mortgages on residential property that is or will be occupied by the borrower, or that is rented, are risk weighted at 35%. [BCBS June 2006 par 72]
Qualifying residential mortgages include:
loans secured by first mortgages on individual condominium residences and one-to
four-unit residences made to a person(s) or guaranteed by a person(s), provided that
such loans are not 90 days or more past due and do not exceed a loan-to-value ratio
of 80%Footnote 11, and
collateral mortgages (first and junior) on individual condominium residences or
one- to four-unit residential dwellings, provided that such loans are made to a
person(s) or guaranteed by a person(s), where no other party holds a senior or
intervening lien on the property to which the collateral mortgage applies and such
loans are not more than 90 days past due and do not, collectively, exceed a loan-to-value
ratio of 80%Footnote 12.
Investments in hotel properties and time-shares are excluded from the definition of qualifying residential property.
Uninsured collateral mortgages that would otherwise qualify as residential mortgages, except that their loan-to-value ratio exceeds 80%, receive a risk weight of 75%.
The Standardized Approach must be used for reverse mortgage exposures. Reverse mortgages are non-recourse loans secured by property that have no defined term and no monthly repayment of principal and interest. The amount owing on a reverse mortgage grows with time as interest is accrued and deferred. The loan is generally repaid from the net proceeds of the sale (i.e. net of disposition costs) after the borrower has vacated the property. Reverse mortgage lenders are repaid the lesser of the fair market value of the home (less disposition costs) at the time it is sold and the amount of the loan. Assuming there is no event of default (for example, failure to pay property taxes and insurance, or failure to keep the home in a good state of repair), reverse mortgage lenders have no recourse to the borrower if the amount realized on the sale of the home is less than the amount owing on the reverse mortgage.
A reverse mortgage exposureFootnote 13 qualifies for a 35% risk weight provided that all of the following conditions are met:
its initial loan to value ratio (LTV) is less than or equal to 40%
its current LTV is less than or equal to 60%
disposition costs on the mortgaged property and risk of appraisal error are not expected to exceed 15%-20% of the current appraised value
the criteria for qualifying residential mortgages set out in section 3.1.9 of the CAR guideline are met (except that there is no requirement for recourse to the borrower for a deficiency)
Further, for a reverse mortgage to qualify for a 35% risk weight, the underwriting institution must have, at mortgage inception and at the time such risk weight is being considered, each of the following:
documented and prudent underwriting standards, including systematic methods for estimating expected occupancy term (which should at minimum refer to standard mortality tables), future real estate appreciation / depreciation, future interest rates on the reverse mortgage and determining appropriate levels for maximum initial LTVs and a maximum dollar amount that may be lent
documented procedures for monitoring loan to value ratios on an ongoing basis, based on outstanding loan amounts, including accrued interest, undrawn balances and up to date property values
documented procedures for obtaining independent reappraisals of the properties at regular intervals, not less than once every five years, with more frequent appraisals as loan to value ratios approach 80%
a documented process to ensure timely reappraisal of properties in a major urban centre where resale home prices in that urban centre decline by more than 10%
documented procedures for ensuring that borrowers remain in compliance with loan conditions
a rigorous method for stress testing the reverse mortgage portfolio that addresses expected occupancy, property value and interest rate assumptions
ongoing monitoring of reverse mortgage stress testing that is incorporated in the institution’s Pillar II Internal Capital Adequacy Assessment and capital planning processes
For purposes of calculating risk weighted assets, current LTV is defined as:
the reverse mortgage exposure (as defined in the footnote) divided by:
where the most recent appraisal is greater than the original appraisal, the greater of the original appraised value or 80% of the most recent appraised value of the property,
where the most recent appraisal is less than the original appraisal, the most recent appraised value of the property.
The following table sets out the risk weights that apply to reverse mortgage exposures:
A reverse mortgage exposure that originally qualified for a 35% risk weight but now has a current LTV that is greater than 60%, but less than or equal to 75%, is risk weighted at 75%.
A reverse mortgage exposure that had an initial LTV greater than 40% (but that otherwise would have qualified for a 35% risk weight) is risk weighted at 50%, provided its current loan to value ratio is less than or equal to 60%.
All reverse mortgage exposures with current LTVs greater than 60% and less than or equal to 75%, except those that could not (regardless of original LTV) qualify for the 35% or 50% risk weight are risk weighted at 75%.
All reverse mortgage exposures with current LTVs greater than 75% and less than or equal to 85%, and all reverse mortgages that could not (regardless of the original LTV) qualify for a 35% or 50% risk weight and which have a current LTV less than or equal to 85%, are risk weighted at 100%.
Where a reverse mortgage exposure has a current LTV greater than 85%, the exposure amount that exceeds 85% LTV is deducted from capital. The remaining amount is risk-weighted at 100%.
0% Risk weight
NHA mortgage-backed securities that are guaranteed by the Canada Mortgage and Housing Corporation (CMHC), in recognition of the fact that obligations incurred by CMHC are legal obligations of the Government of Canada.
35% Risk weight
Pass-through mortgage-backed securities that are fully and specifically secured against qualifying residential mortgages (see 3.1.9.).
100% Risk weight
amounts receivable resulting from the sale of mortgages under NHA mortgage-backed securities programs.
Mortgage-backed securities that are of pass-through type and are effectively a direct holding of the underlying assets shall receive the risk-weight of the underlying assets, provided that all the following conditions are met:
The underlying mortgage pool contains only mortgages that are fully performing when the mortgage-backed security is created.
The securities must absorb their pro-rata share of any losses incurred.
A special-purpose vehicle should be established for securitization and administration of the pooled mortgage loans.
The underlying mortgages are assigned to an independent third party for the benefit of the investors in the securities who will then own the underlying mortgages.
The arrangements for the special-purpose vehicle and trustee must provide that the following obligations are observed:
If a mortgage administrator or a mortgage servicer is employed to carry out administration functions, the vehicle and trustee must monitor the performance of the administrator or servicer.
The vehicle and/or trustee must provide detailed and regular information on structure and performance of the pooled mortgage loans.
The vehicle and trustee must be legally separate from the originator of the pooled mortgage loans.
The vehicle and trustee must be responsible for any damage or loss to investors created by their own or their mortgage servicer’s mismanagement of the pooled mortgages.
The trustee must have a first priority charge on underlying assets on behalf of the holders of the securities.
The agreement must provide for the trustee to take clearly specified steps in cases when the mortgagor defaults.
The holder of the security must have a pro-rata share in the underlying mortgage assets or the vehicle that issues the security must have only liabilities related to the issuing of the mortgage-backed security.
The cash flows of the underlying mortgages must meet the cash flow requirements of the security without undue reliance on any reinvestment income.
The vehicle or trustee may invest cash flows pending distribution to investors only in short-term money market instruments (without any material reinvestment risk) or in new mortgage loans.
Mortgage-backed securities that do not meet these conditions will receive a risk-weight of 100%. Stripped mortgage-backed securities or different classes of securities (senior/junior debt, residual tranches) that bear more than their pro-rata share of losses will automatically receive a 100% risk weight.
Where the underlying pool of assets is comprised of assets that would attract different risk weights, the risk weight of the securities will be the highest risk weight associated with risk- weighted assets.
For the treatment of mortgage-backed securities issued in tranches, refer to chapter 7, Structured Products.
A securities repurchase (repo) is an agreement whereby a transferor agrees to sell securities at a specified price and repurchase the securities on a specified date and at a specified price. Since the transaction is regarded as a financing for accounting purposes, the securities remain on the balance sheet. Given that these securities are temporarily assigned to another party, the risk-weighted assets associated with this exposure should be the higher of risk- weighted assets calculated using:
the risk weight of the security, or
the risk weight of the counterparty to the transaction, recognizing any eligible collateral; see Chapter 5.
A reverse repurchase agreement is the opposite of a repurchase agreement, and involves the purchase and subsequent resale of a security. Reverse repos are treated as collateralised loans, reflecting the economic reality of the transaction. The risk is therefore to be measured as an exposure to the counterparty. If the asset temporarily acquired is a security that qualifies as eligible collateral per chapter 5, the risk-weighted exposure may be reduced accordingly.
In securities lending, institutions can act as a principal to the transaction by lending their own securities or as an agent by lending securities on behalf of their clients.
When the institution lends its own securities, the credit risk is based on the higher of:
the credit risk of the instrument lent, and
the counterparty credit risk of the borrower of the securities. This risk could be reduced if the institution held eligible collateral (refer to chapter 5). Where the institution lends securities through an agent and receives an explicit guarantee of the return of the securities, the institution’s counterparty is the agent.
When the institution, acting as agent, lends securities on behalf of the client and guarantees that the securities lent will be returned or the institution will reimburse the client for the current market value, the credit risk is based on the counterparty credit risk of the borrower of the securities. This risk could be reduced if the institution held eligible collateral (see chapter 5).
Commercial mortgages are risk-weighted at 100%.
The unsecured portion of any loan (other than a qualifying residential mortgage loan) that is past due for more than 90 days, net of specificFootnote 14 allowances , will be risk-weighted as follows:
150% risk weight when specific allowances are less than 20% of the outstanding amount of the loan.
100% risk weight when specific allowances are more than 20% and less than 100% of the outstanding amount of the loan.
[BCBS June 2006 par 75]
For the purpose of defining the secured portion of the past due loan, eligible collateral and guarantees will be the same as for credit risk mitigation purposes (see chapter 5). For risk- weighting purposes, past due retail loans are to be excluded from the overall regulatory retail portfolio when assessing the granularity criterion specified in 3.1.8. [BCBS June 2006 par 76]
Qualifying residential mortgage loans that are past due for more than 90 days will be risk weighted at 100%, net of specific allowances. [BCBS June 2006 par 78]
The following claims will be risk weighted at 150% or higher:
claims on sovereigns, PSEs, banks, and securities firms rated below B-,
claims on corporates rated below BB-,
past due loans as set out above, and
securitisation tranches that are rated between BB+ and BB- will be risk weighted at 350% as set out in Chapter 7 – Structured Credit Products, paragraph 56.
[BCBS June 2006 par 79]
Chapter 2 of this Guideline requires banks to deduct certain direct and indirect investments in financial institutions. Exposures, including underlying exposures held by funds, that are required to be deducted according to Chapter 2 should not be risk weighted and therefore are excluded from the treatment in paragraphs 52-69 below.
Equity investments in funds that are held in the banking book must be treated in a manner consistent with one or more of the following three approaches, which vary in their risk sensitivity and conservatism: the “look-through approach” (LTA), the “mandate-based approach” (MBA), and the “fall-back approach” (FBA). [BCBS December 2013, par 80(i)]
(i) The look-through approach
The LTA requires a bank to risk weight the underlying exposures of a fund as if the exposures were held directly by the bank. This is the most granular and risk-sensitive approach. It must be used when:
there is sufficient and frequent information provided to the bank regarding the underlying exposures of the fund; and
such information is verified by an independent third party.
[BCBS December 2013, par 80(ii)]
To satisfy condition (a) above, the frequency of financial reporting of the fund must be the same as, or more frequent than, that of the bank’s and the granularity of the financial information must be sufficient to calculate the corresponding risk weightsFootnote 15. To satisfy condition (b) above, there must be verification of the underlying exposures by an independent third party, such as the depository or the custodian bank or, where applicable, the management company. [BCBS December 2013, par 80(iii)]
Under the LTA banks must risk weight all underlying exposures of the fund as if those exposures were directly held. This includes, for example, any underlying exposure arising from the fund’s derivatives activities (for situations in which the underlying receives a risk weighting treatment under Pillar 1) and the associated counterparty credit risk (CCR) exposure. Instead of determining a credit valuation adjustment (CVA) charge associated with the fund’s derivatives exposures in accordance with section 4.1.7 of Chapter 4, banks must multiply the CCR exposure by a factor of 1.5 before applying the risk weight associated with the counterpartyFootnote 16. [BCBS December 2013, par 80(iv)]
Banks may rely on third-party calculations for determining the risk weights associated with their equity investments in funds (i.e. the underlying risk weights of the exposures of the fund) if they do not have adequate data or information to perform the calculations themselves. In such cases, the applicable risk weight shall be 1.2 times higher than the one that would be applicable if the exposure were held directly by the bankFootnote 17. [BCBS December 2013, par 80(v)]
Example of the calculation of RWA using the LTA:
Consider a fund that replicates an equity index. Moreover, assume the following:
Balance sheet exposures of $100 will be risk weighted according to the risk weights applied for cash (RW=0%), government bonds (RW=0%), and non-significant equity holdings of commercial entities (RW = 100%).
The leverage of the fund is 100/95≈1.05.
Therefore, the risk-weighted assets for the bank’s equity investment in the fund are calculated as follows:
Avg RWfund* Leverage*Equity investment
= ((RWAcash + RWAbonds + RWAequities)/TotalAssetsfund)*Leverage*Equity investment
= (($20*0% + $30*0% + $50*100%)/100) * 1.05 * (20%*95)
(ii) The mandate-based approach
The second approach, the MBA, provides a method for calculating regulatory capital that can be used when the conditions for applying the LTA are not met. [BCBS December 2013, par 80(vi)]
Under the MBA banks may use the information contained in a fund’s mandate or in the national regulations governing such investment fundsFootnote 18. To ensure that all underlying risks are taken into account (including CCR) and that the MBA renders capital requirements no less than the LTA, the risk-weighted assets for the fund’s exposures are calculated as the sum of the following three items:
Balance sheet exposures (ie the funds’ assets) are risk weighted assuming the underlying portfolios are invested to the maximum extent allowed under the fund’s mandate in those assets attracting the highest capital requirements, and then progressively in those other assets implying lower capital requirements. If more than one risk weight can be applied to a given exposure, the maximum risk weight applicable must be usedFootnote 19.
Whenever the underlying risk of a derivative exposure or an off-balance-sheet item receives a risk weighting treatment under Pillar 1, the notional amount of the derivative position or of the off-balance sheet exposure is risk weighted accordinglyFootnote 20 Footnote 21.
The CCR associated with the fund’s derivative exposures is calculated using the Current Exposure Method, set out in section 4.1.6 of Chapter 4 of this Guideline, which includes a replacement cost and potential future exposure (PFE) component. Whenever the replacement cost is unknown, the exposure measure for CCR will be calculated in a conservative manner by using the notional amount as a proxy for the replacement cost. Whenever the PFE is unknown, the maximum add-on factor of 15%Footnote 22 appliesFootnote 23. The risk weight associated with the counterparty is applied to the sum of the replacement cost and PFE. Instead of determining a CVA charge associated with the fund’s derivative exposures in accordance with section 4.1.7 of Chapter 4, banks must multiply the CCR exposure by a factor of 1.5 before applying the risk weight associated with the counterpartyFootnote 24.
[BCBS December 2013, par 80(vii)]
(iii) The fall-back approach
(iv) Treatment of funds that invest in other funds
(v) Partial use of an approach
(vi) Exclusions to the look-through, mandate-based and fall-back approaches
Equity holdings in entities whose debt obligations qualify for a zero risk weight are excluded from the LTA, MBA and FBA approaches (including those publicly sponsored entities where a zero risk weight can be applied). [BCBS December 2013, par 80(xi)]
To promote specified sectors of the economy, supervisors may exclude from the equity investments in funds capital charges equity holdings made under legislated programmes that provide significant subsidies or the investment to the bank and involve some form of government oversight and restrictions on the equity investments. Examples of restrictions are limitations on the size and types of businesses in which the bank is investing, allowable amounts of ownership interests, geographical location and other pertinent factors that limit the potential risk of the investment to the bank. Equity holdings made under legislated programmes can only be excluded up to an aggregate of 10% of a bank’s total regulatory capital. [BCBS December 2013, par 80(xii)]
(vii) Leverage adjustments
Leverage is defined as the ratio of total assets to total equity. National discretion may be applied to choose a more conservative leverage metric, if deemed appropriate. Leverage is taken into account in the MBA by using the maximum financial leverage permitted in the fund’s mandate or in the national regulation governing the fund. [BCBS December 2013, par 80(xiii)]
When determining the capital requirement related to its equity investment in a fund, a bank must apply a leverage adjustment to the average risk weight of the fund, as set out in paragraph 68, subject to a cap of 1,250%. [BCBS December 2013, par 80(xiv)]
After calculating the total risk-weighted assets of the fund according to the LTA or the MBA, banks will calculate the average risk weight of the fund (Avg RWfund) by dividing the total risk-weighted assets by the total assets of the fund. Using Avg RWfund and taking into account the leverage of a fund (Lvg), the risk-weighted assets for a bank’s equity investment in a fund can be represented as follows:
RWAinvestment = Avg RWfund * Lvg * equity investment
[BCBS December 2013, par 80(xv)]
RWAinvestment = RWAfund * percentage of shares
[BCBS December 2013, par 80(xvi)]
cash and gold bullion held in the institution’s own vaults or on an allocated basis to the extent backed by bullion liabilities,
unrealized gains and accrued receivables on foreign exchange and interest rate-related off-balance sheet transactions where they have been included in the off- balance sheet calculations, and
all deductions from capital, as specified in chapter 2.
20% Risk weight
cheques and other items in transit.
the amount of non-significant investments in the capital of banking, financial and insurance entities to which a credit risk standardized approach applies not deducted from capital
non-significant investments in the equity of non-financial entities,
premises, plant and equipment and other fixed assets,
real estate and other investments (including non-consolidated investment participation in other companies),
prepaid expenses such as property taxes and utilities,
deferred charges such as mortgage origination costs, and
all other assets.
250% Risk weight
items described as Threshold Deductions (basket) in Chapter 2 - Definition of Capital, Section 2.3.1 which fall below the applicable thresholds.
1250% Risk weight
refer to section 2.3.4 of Chapter 2 – Definition of Capital.
Purchased retail receivables that meet the four criteria for regulatory retail exposures, as specified in paragraph 25, are risk weighted at 75%. Purchased receivables to corporate entities or exposures that do not meet the retail definition, are risk-weighted as corporate exposures as per section 3.1.7.
In addition, as part of the institution’s risk management processes, it should establish underwriting criteria and monitoring procedures for all purchased assets/receivables, particularly where an institution regularly purchases assets from a seller pursuant to a facility or program. Therefore, an institution is expected to:
establish quality criteria both for receivables to be purchased and for the seller/servicer of the receivables,
regularly monitor the purchased receivables to ensure they meet the criteria,
regularly monitor the financial condition of the seller/servicer of the receivables,
have legal certainty that the institution has ownership of the receivables and all associated cash remittances,
have confidence that current and future advances or purchases can be repaid from the liquidation or collections from the receivables pool,
periodically verify the accuracy of reports related to both the seller/servicer and the receivables/obligors,
periodically verify the credit and collection policies of the seller/servicer, and
establish procedures for monitoring adherence to all contractual terms by the seller/servicer and regular audits of critical phases of the program.
The definitions in this section apply to off-balance sheet instruments. The term “off- balance sheet instruments”, as used in this guideline, encompasses guarantees, commitments, derivatives, and similar contractual arrangements whose full notional principal amount may not necessarily be reflected on the balance sheet. Such instruments are subject to a capital charge irrespective of whether they have been recorded on the balance sheet at market value.
Institutions should closely monitor securities, commodities, and foreign exchange transactions that have failed, starting the first day they fail. A capital charge for failed transactions should be calculated in accordance with Chapter 4 , Section 4.2. With respect to unsettled securities, commodities, and foreign exchange transactions that are not processed through a delivery-versus-payment (DvP) or payment-versus- payment (PvP) mechanism, institutions should calculate a capital charge as set forth in Chapter 4 .
The credit equivalent amount of Securities Financing Transactions (SFT)Footnote 25 and derivatives that expose a bank to counterparty credit riskFootnote 26 is to be calculated under the rules set forth in Chapter 4 , Section 4.1 or Chapter 5 (for SFTs not covered by the Internal Model Method). Chapter 4 applies to derivatives held in the both the banking book and trading book.
Direct credit substitutes include guarantees or equivalent instruments backing financial claims. With a direct credit substitute, the risk of loss to the institution is directly dependent on the creditworthiness of the counterparty.
Examples of direct credit substitutes include:
guarantees given on behalf of customers to stand behind the financial obligations of the customer and to satisfy these obligations should the customer fail to do so; for example, guarantees of:
payment for existing indebtedness for services
payment with respect to a purchase agreement
lease, loan or mortgage payments
payment of uncertified cheques
remittance of (sales) tax to the government
payment of existing indebtedness for merchandise purchased
payment of an unfunded pension liability
reinsurance of financial obligations,
standby letters of credit or other equivalent irrevocable obligations, serving as financial guarantees, such as letters of credit supporting the issue of commercial paper,
risk participation in bankers’ acceptances and risk participation in financial letters of credit. Risk participation constitutes guarantees by the participating institutions such that, if there is a default by the underlying obligor, they will indemnify the selling institution for the full principal and interest attributable to them,
securities lending transactions, where the institution is liable to its customer for any failure to recover the securities lent, and
credit derivatives in the banking book where a bank is selling credit protection.
Transaction-related contingencies relate to the ongoing business activities of a counterparty, where the risk of loss to the reporting institution depends on the likelihood of a future event that is independent of the creditworthiness of the counterparty. Essentially, transaction-related contingencies are guarantees that support particular performance of non- financial or commercial contracts or undertakings, rather than supporting customers’ general financial obligations. Performance-related guarantees specifically exclude items relating to non- performance of financial obligations.
Performance-related and non-financial guarantees include items such as:
performance bonds, warranties and indemnities. Performance standby letters of credit represent obligations backing the performance of non-financial or commercial contracts or undertakings. These include arrangements backing:
subcontractors’ and suppliers' performance
labour and material contracts
delivery of merchandise, bids or tender bonds
guarantees of repayment of deposits or prepayments in cases of non- performance,
customs and excise bonds. The amount recorded for such bonds should be the reporting institution's maximum liability.
These include short-term, self-liquidating trade-related items such as commercial and documentary letters of credit issued by the institution that are, or are to be, collateralized by the underlying shipment.
Letters of credit issued on behalf of a counterparty back-to-back with letters of credit of which the counterparty is a beneficiary ("back-to-back" letters) should be reported as documentary letters of credit.
Letters of credit advised by the institution for which the institution is acting as reimbursement agent should not be considered as a risk asset.
A repurchase agreement is a transaction that involves the sale of a security or other asset with the simultaneous commitment by the seller that, after a stated period of time, the seller will repurchase the asset from the original buyer at a pre-determined price. A reverse repurchase agreement consists of the purchase of a security or other asset with the simultaneous commitment by the buyer that, after a stated period of time, the buyer will resell the asset to the original seller at a pre-determined price. In any circumstance where they are not reported on- balance sheet, they should be reported as an off-balance sheet exposure with a 100% credit conversion factor.
A commitment to purchase a loan, security, or other asset at a specified future date, usually on prearranged terms.
An agreement between two parties whereby one will pay and other receive an agreed rate of interest on a deposit to be placed by one party with the other at some pre-determined date in the future. Such deposits are distinct from future forward rate agreements in that, with forward/forwards, the deposit is actually placed.
Transactions where only a part of the issue price or notional face value of a security purchased has been subscribed and the issuer may call for the outstanding balance (or a further installment), either on a date pre-determined at the time of issue or at an unspecified future date.
These are arrangements whereby a borrower may issue short-term notes, typically three to six months in maturity, up to a prescribed limit over an extended period of time, commonly by means of repeated offerings to a tender panel. If at any time the notes are not sold by the tender at an acceptable price, an underwriter (or group of underwriters) undertakes to buy them at a prescribed price.
These are arrangements between two parties where at some pre-determined future date a cash settlement will be made for the difference between the contracted rate of interest and the current market rate on a pre-determined notional principal amount for a pre-determined period.
In an interest rate swap, two parties contact to exchange interest service payments on the same amount of notional indebtedness. In most cases, fixed interest rate payments are provided by one party in return for variable rate payments from the other and vice versa. However, it is possible that variable interest payments may be provided in return for other variable interest rate payments.
An option is an agreement between two parties where the seller of the option for compensation (premium/fee) grants the buyer the future right, but not the obligation, to buy from the seller, or to sell to the seller, either on a specified date or during a specified period, a financial instrument or commodity at a price agreed when the option is arranged. Other forms of interest rate options include interest rate cap agreements and collar (floor/ceiling) agreements.
A forward foreign exchange contract is an agreement between an institution and a counterparty in which the institution agrees to sell to or purchase from the counterparty a fixed amount of foreign currency at a fixed rate of exchange for delivery and settlement on a specified date in the future or within a fixed optional period.
A cross currency swap is a transaction in which two parties exchange currencies and the related interest flows for a period of time. Cross currency swaps are used to swap fixed interest rate indebtedness in different currencies.
Cross currency interest rate swaps combine the elements of currency and interest rate swaps.
A future is a standardized contractual obligation to make or take delivery of a specified quantity of a commodity (financial instrument, foreign currency, etc.) on a specified future date at a specified future price established in a central regulated marketplace.
Precious metals contracts and financial contracts on commodities can involve spot, forward, futures and option contracts. Precious metals are mainly gold, silver, and platinum. Commodities are bulk goods such as grains, metals and foods traded on a commodities exchange or on the spot market. For capital purposes, gold contracts are treated the same as foreign exchange contracts.
Non-equity warrants include cash settlement options/contracts whose values are determined by the movements in a given underlying index, product, or foreign exchange over time. Where non-equity warrants or the hedge for such warrants expose the financial institution to counterparty credit risk, the credit equivalent amount should be determined using the current exposure method for exchange rate contracts.
The face amount (notional principal amount) of off-balance sheet instruments does not always reflect the amount of credit risk in the instrument. To approximate the potential credit exposure of non-derivative instruments, the notional amount is multiplied by the appropriate credit conversion factor (CCF) to derive a credit equivalent amountFootnote 28. The credit equivalent amount is treated in a manner similar to an on-balance sheet instrument and is assigned the risk weight appropriate to the counterparty or, if relevant, the guarantor or collateral. The categories of credit conversion factors are outlined below.
100% Conversion factor
Direct credit substitutes (general guarantees of indebtedness and guarantee-type instruments, including standby letters of credit serving as financial guarantees for, or supporting, loans and securities),
Acquisitions of risk participation in bankers' acceptances and participation in direct credit substitutes (for example, standby letters of credit),
Sale and repurchase agreements and asset sales with recourseFootnote 29,
Partly paid shares and securitiesFootnote 23,
Forward agreements (contractual obligations) to purchase assets, including financing facilities with certain drawdown and forward depositsFootnote 23, and
Written put options on specified assets with the characteristics of a credit enhancementFootnote 30.
50% Conversion factor
Transaction-related contingencies (for example, bid bonds, performance bonds, warranties, and standby letters of credit related to a particular transaction),
Commitments with an original maturity exceeding one year, including underwriting commitments and commercial credit lines, and
Revolving underwriting facilities (RUFs), note issuance facilities (NIFs) and other similar arrangements.
20% Conversion factor
Short-term, self-liquidating trade-related contingencies, including commercial/ documentary letters of credit (Note: a 20% CCF is applied to both issuing and confirming banks),
Commitments with an original maturity of one year or less, and
0% Conversion factor
Commitments that are unconditionally cancellable at any time without prior notice.
[BCBS June 2006 par 82 to 89]
The treatment of forwards, swaps, purchased options and other similar derivatives needs special attention because institutions are not exposed to credit risk for the full face value of their contracts (notional principal amount), but only to the potential cost of replacing the cash flow (on contracts showing a positive value) if the counterparty defaults. The credit equivalent amounts are calculated using the current exposure method and are assigned the risk weight appropriate to the counterparty. As an alternative to the current exposure method, institutions may calculate the credit equivalent amount using the internal modelling method, subject to supervisory approval. See Chapter 4, Sections 4.1.5 and 4.1.6 for details on these two methods.
Institutions should closely monitor securities, commodities, and foreign exchange transactions that have failed, starting the first day they fail. A capital charge for failed transactions should be calculated in accordance with Chapter 4 – Settlement and Counterparty Risk, Section 4.2. With respect to unsettled securities, commodities, and foreign exchange transactions that are not processed through a delivery-versus-payment (DvP) or payment-versus- payment (PvP) mechanism, institutions should calculate a capital charge as set forth in Chapter 4– Settlement and Counterparty Risk, Section 4.2.
Commitments are arrangements that obligate an institution, at a client's request, to:
extend credit in the form of loans or participations in loans, lease financing receivables, mortgages (including the undrawn portion of HELOCs), overdrafts, acceptances, letters of credit, guarantees or loan substitutes, or
purchase loans, securities, or other assets
Note that unfunded mortgage commitments are treated as commitments for risk-based capital purposes when the borrower has accepted the commitment extended by the institution and all conditions related to the commitment have been fully satisfied.
Normally, commitments involve a written contract or agreement and some form of consideration, such as a commitment fee.
The credit conversion factor applied to a commitment is dependent on its maturity. Longer maturity commitments are considered to be of higher risk because there is a longer period between credit reviews and less opportunity to withdraw the commitment if the credit quality of the drawer deteriorates.
Conversion factors apply to commitments as set out below.
Commitments that are unconditionally cancellable at any time by the institution without notice or that effectively provide for automatic cancellation due to deterioration in the borrower’s creditworthiness. This implies that the institution conducts a formal review of the facility at least annually, thus giving it an opportunity to take note of any perceived deterioration in credit quality. Retail commitments are unconditionally cancellable if the term permits the institution to cancel them to the full extent allowable under consumer protection and related legislation.
Commitments with an original maturity of one year and under.
Commitments with an original maturity of over one year,
NIFs and RUFs,
the undrawn portion of a commitment to provide a loan that will be drawn down in a number of tranches, some less than and some over one year, and
forward commitments (where the institution makes a commitment to issue a commitment) if the loan can be drawn down more than one year after the institution’s initial undertaking is signed.
[BCBS June 2006 par 83]
Institutions should use original maturity (as defined below) to report these instruments.
The maturity of a commitment should be measured from the date when the commitment was accepted by the customer, regardless of whether the commitment is revocable or irrevocable, conditional or unconditional, until the earliest date on which:
the commitment is scheduled to expire, or
the institution can, at its option, unconditionally cancel the commitment.
A material adverse change clause is not considered to give sufficient protection for a commitment to be considered unconditionally cancellable.
Where the institution commits to granting a facility at a future date (a forward commitment), the original maturity of the commitment is to be measured from the date the commitment is accepted until the final date that drawdowns are permitted.
If both parties agree, a commitment may be renegotiated before its term expires. If the renegotiation process involves a credit assessment of the customer consistent with the institution’s credit standards, and provides the institution with the total discretion to renew or extend the commitment and to change any other terms and conditions of the commitment, then on the date of acceptance by the customer of the revised terms and conditions, the original commitment may be deemed to have matured and a new commitment begun. If new terms are not reached, the original commitment will remain in force until its original maturity date.
This renegotiation process must be clearly documented.
In syndicated and participated transactions, a participating institution must be able to exercise its renegotiation rights independent of the other syndicate members.
Where these conditions are not met, the original start date of the commitment must be used to determine maturity.
A 0% credit conversion factor is applied to undated or open-ended commitments, such as unused credit card lines, personal lines of credit, and overdraft protection for personal chequing accounts that are unconditionally cancellable at any time.
Open-ended commitments that are cancellable by the financial institution at any time subject to a notice period do not constitute unconditionally cancellable commitments and are converted at 50%. Long-term commitments must be cancellable without notice to be eligible for the 0% conversion factor.
A 50% credit conversion factor is applied to a commitment to provide a loan (or purchase an asset) to be drawn down in a number of tranches, some one year and under and some over one year. In these cases, the ability to renegotiate the terms of later tranches should be regarded as immaterial. Often these commitments are provided for development projects from which the institution may find it difficult to withdraw without jeopardizing its investment.
Where the facility involves unrelated tranches, and where conversions are permitted between the over- and under-one year tranches (i.e., where the borrower may make ongoing selections as to how much of the commitment is under one year and how much is over), then the entire commitment should be converted at 50%.
Where the facility involves unrelated tranches with no conversion between the over- and under-one year tranches, each tranche may be converted separately, depending on its maturity.
For commitments that vary in amount over the life of the commitment, such as the financing of a business subject to seasonal variation in cash flow, the conversion factor should apply to the maximum unutilized amount that can be drawn under the remaining period of the facility.
A commitment to provide a loan that has a maturity of over one year but that must be drawn down within a period of less than one year may be treated as an under-one-year instrument, as long as any undrawn portion of the facility is automatically cancelled at the end of the drawdown period.
However, if through any combination of options or drawdowns, repayments and redrawdowns, etc., the client can access a line of credit past one year, with no opportunity for the institution to unconditionally cancel the commitment within one year, the commitment shall be converted at 50%.
Where there is a commitment to provide an off-balance sheet item, institutions are to apply the lower of the two applicable credit conversion factors.
National supervisors are responsible for determining on a continuous basis whether an external credit assessment institution (ECAI) meets the criteria listed in the paragraph below. National supervisors should refer to the IOSCO Code of Conduct Fundamentals for Credit Rating Agencies when determining ECAI eligibility. The assessments of ECAIs may be recognised on a limited basis, e.g. by type of claims or by jurisdiction. The supervisory process for recognising ECAIs should be made public to avoid unnecessary barriers to entry. [BCBS June 2006 par 90 and BCBS June 2011 par 120]]
OSFI conducted a process to determine which of the major international rating agencies would be recognized. It included completion of a self-assessment template and submission of data required to complete a mapping exercise (see paragraph 124). As a result of this process, OSFI will permit banks to recognize credit ratings from the following rating agencies for capital adequacy purposes:
An ECAI must satisfy each of the following six criteria.
The methodology for assigning credit assessments must be rigorous, systematic, and subject to some form of validation based on historical experience. Moreover, assessments must be subject to ongoing review and responsive to changes in financial condition. Before being recognised by supervisors, an assessment methodology for each market segment, including rigorous backtesting, must have been established for at least one year and preferably three years.
An ECAI should be independent and should not be subject to political or economic pressures that may influence the rating. The assessment process should be as free as possible from any constraints that could arise in situations where the composition of the board of directors or the shareholder structure of the assessment institution may be seen as creating a conflict of interest.
The individual assessments, the key elements underlining the assessments and whether the issuer participated in the assessment process should be publically available on a non-selective basis, unless they are private assessment. In addition, the general procedures, methodologies and assumptions for arriving at assessments used by the ECAI should be publicly available.
An ECAI should disclose the following information: its code of conduct; the general nature of its compensation arrangements with assessed entities; its assessment methodologies, including the definition of default, the time horizon, and the meaning of each rating; the actual default rates experienced in each assessment category; and the transitions of the assessments, e.g. the likelihood of AA ratings becoming A over time.
An ECAI should have sufficient resources to carry out high quality credit assessments. These resources should allow for substantial ongoing contact with senior and operational levels within the entities assessed in order to add value to the credit assessments. Such assessments should be based on methodologies combining qualitative and quantitative approaches.
To some extent, credibility is derived from the criteria above. In addition, the reliance on an ECAI’s external credit assessments by independent parties (investors, insurers, trading partners) is evidence of the credibility of the assessments of an ECAI. The credibility of an ECAI is also underpinned by the existence of internal procedures to prevent the misuse of confidential information. In order to be eligible for recognition, an ECAI does not have to assess firms in more than one country.
[BCBS June 2006 par 91 and BCBS June 2011 par 120]
In additional to the above criteria, OSFI requires that an ECAI be recognized as a designated rating organization by the Canadian Securities Administrators National Instrument 25-101 in order to be an eligible ECAI in Canada.
Supervisors will be responsible for assigning eligible ECAIs’ assessments to the risk weights available under the standardised risk weighting framework, i.e. deciding which assessment categories correspond to which risk weights. The mapping process should be objective and should result in a risk weight assignment consistent with that of the level of credit risk reflected in the tables above. It should cover the full spectrum of risk weights. [BCBS June 2006 par 92]
(AAA to AA-)
(A+ to A-)
(BBB+ to BBB-)
(BB+ to BB-)
(B+ to B-)
When conducting such a mapping process, factors that supervisors should assess include, among others, the size and scope of the pool of issuers that each ECAI covers, the range and meaning of the assessments that it assigns, and the definition of default used by the ECAI. In order to promote a more consistent mapping of assessments into the available risk weights and help supervisors in conducting such a process, Annex 2 of the revised Framework provides guidance as to how such a mapping process may be conducted. [BCBS June 2006 par 93]
Banks must use the chosen ECAIs and their ratings consistently for each type of claim, for both risk weighting and risk management purposes. Banks will not be allowed to “cherry- pick” the assessments provided by different ECAIs and to arbitrarily change the use of ECAIs. [BCBS June 2006 par 94 and BCBS June 2011 par 121]
Banks must disclose ECAIs that they use for the risk weighting of their assets by type of claims, the risk weights associated with the particular rating grades as determined by supervisors through the mapping process as well as the aggregated risk-weighted assets for each risk weight based on the assessments of each eligible ECAI. [BCBS June 2006 par 95]
If there is only one assessment by an ECAI chosen by a bank for a particular claim, that assessment should be used to determine the risk weight of the claim. [BCBS June 2006 par 96]
If there are two assessments by ECAIs chosen by a bank which map into different risk weights, the higher risk weight will be applied. [BCBS June 2006 par 97]
If there are three or more assessments with different risk weights, the assessments corresponding to the two lowest risk weights should be referred to and the higher of those two risk weights will be applied. [BCBS June 2006 par 98]
Where a bank invests in a particular issue that has an issue-specific assessment, the risk weight of the claim will be based on this assessment. Where the bank’s claim is not an investment in a specific assessed issue, the following general principles apply.
In circumstances where the borrower has a specific assessment for an issued debt - but the bank’s claim is not an investment in this particular debt ─ a high quality credit assessment (one which maps into a risk weight lower than that which applies to an unrated claim) on that specific debt may only be applied to the bank’s unassessed claim if this claim ranks pari passu or senior to the claim with an assessment in all respects. If not, the credit assessment cannot be used and the unassessed claim will receive the risk weight for unrated claims.
In circumstances where the borrower has an issuer assessment, this assessment typically applies to senior unsecured claims on that issuer. Consequently, only senior claims on that issuer will benefit from a high quality issuer assessment. Other unassessed claims of a highly assessed issuer will be treated as unrated. If either the issuer or a single issue has a low quality assessment (mapping into a risk weight equal to or higher than that which applies to unrated claims), an unassessed claim on the same counterparty that ranks pari passu or is subordinated to either the senior unsecured issuer assessment or the exposure assessment will be assigned the same risk weight as is applicable to the low quality assessment.
[BCBS June 2006 par 99 and BCBS June 2011 par 118]
Whether the bank intends to rely on an issuer- or an issue-specific assessment, the assessment must take into account and reflect the entire amount of credit risk exposure the bank has with regard to all payments owed to it.Footnote 32 [BCBS June 2006 par 100]
In order to avoid any double counting of credit enhancement factors, no supervisory recognition of credit risk mitigation techniques will be taken into account if the credit enhancement is already reflected in the issue specific rating (see Chapter 5 – Credit Risk Mitigation, paragraph 8). [BCBS June 2006 par 101]
Where unrated exposures are risk weighted based on the rating of an equivalent exposure to that borrower, the general rule is that foreign currency ratings would be used for exposures in foreign currency. Domestic currency ratings, if separate, would only be used to risk weight claims denominated in the domestic currency.Footnote 33 [BCBS June 2006 par 102]
For risk-weighting purposes, short-term assessments are deemed to be issue-specific. They can only be used to derive risk weights for claims arising from the rated facility. They cannot be generalised to other short-term claims. In no event can a short-term rating be used to support a risk weight for an unrated long-term claim. Short-term assessments may only be used for short-term claims against banks and corporates. The table below provides a framework for banks’ exposures to specific short-term facilities, such as a particular issuance of commercial paper:
[BCBS June 2006 par 103]
If a short-term rated facility attracts a 50% risk-weight, unrated short-term claims cannot attract a risk weight lower than 100%. If an issuer has a short-term facility with an assessment that warrants a risk weight of 150%, all unrated claims, whether long-term or short- term, should also receive a 150% risk weight, unless the bank uses recognised credit risk mitigation techniques for such claims. [BCBS June 2006 par 104]
When a short-term assessment is to be used, the institution making the assessment needs to meet all of the eligibility criteria for recognising ECAIs as presented in paragraph 122 in terms of its short-term assessment. [BCBS June 2006 par 106]
External assessments for one entity within a corporate group cannot be used to risk weight other entities within the same group. [BCBS June 2006 par 107]
As a general rule, banks should use solicited ratings from eligible ECAIs. National supervisory authorities may, however, allow banks to use unsolicited ratings in the same way as solicited ratings if they are satisfied that the credit assessments of unsolicited ratings are not inferior in quality to the general quality of solicited ratings . However, there may be the potential for ECAIs to use unsolicited ratings to put pressure on entities to obtain solicited ratings. Such behaviour, when identified, should cause supervisors to consider whether to continue recognising such ECAIs as eligible for capital adequacy purposes. [BCBS June 2006 par 108 and BCBS June 2011 par 121]
Banks are not permitted to rely on any unsolicited rating in determining an asset’s risk weight except where the asset is a sovereign exposure and solicited ratings are not available. As noted in paragraph 139, the unsolicited rating must not be inferior to the general quality of solicited ratings.
For institutions with a fiscal year ending October 31 or December 31, respectively.
Return to footnote 1
Following the format: [BCBS June 2006 par x]
Return to footnote 2
Under IFRS 9, Stage 3 allowances and partial write-offs are considered to be specific allowances, while Stage 1 and Stage 2 allowances are considered to be general allowances.
Return to footnote 3
This notation refers to the methodology used by Standard and Poor’s. Refer to section 22.214.171.124. to determine the applicable risk weight for other rating agency methodologies.
Return to footnote 4
This is to say that the bank would also have corresponding liabilities denominated in the domestic currency.
Return to footnote 5
This lower risk weight may be extended to the risk weighting of collateral and guarantees. See section 5.1.3. and 5.1.5.
Return to footnote 6
The consensus country risk classification is available on the OECD’s website (http://www.oecd.org) in the Export Credit Arrangement web page of the Trade Directorate.
Return to footnote 7
Return to footnote 8
Return to footnote
Return to footnote 9
That is, capital requirements that are comparable to those applied to banks in this Framework. Implicit in the meaning of the word “comparable” is that the securities firm (but not necessarily its parent) is subject to consolidated regulation and supervision with respect to any downstream affiliates.
Return to footnote 10
The property value at origination of the loan is to be used in determining the loan-to-value ratio.
Return to footnote 11
The loan-to-value for purposes of HELOCs is the authorized amount of the HELOC.
Return to footnote 12
Reverse mortgage exposure means all advances, plus accrued interest and 50% of undrawn amounts, net of specific allowances. Undrawn amounts on reverse mortgages do not include future loan growth due to capitalizing interest. Undrawn amounts are treated as undrawn commitments and are subject to a credit conversion factor of 50% (i.e., commitments with an original maturity exceeding one year).
Return to footnote 13
Return to footnote 14
An external audit is not required.
Return to footnote 15
A bank is not required to apply the 1.5 factor for situations in which the CVA capital charge would not otherwise be applicable. This includes: (i) transactions with a central counterparty and (ii) securities financing transactions (SFTs), unless the bank’s national supervisor determines that the bank’s CVA loss exposure arising from SFTs are material.
Return to footnote 16
For instance, any exposure that is subject to a 20% risk weight under the Standardised Approach would be weighted at 24% (1.2 * 20%) when the look through is performed by a third party.
Return to footnote 17
Information used for this purpose is not strictly limited to a fund’s mandate or national regulations governing like funds. It may also be drawn from other disclosures of the fund.
Return to footnote 18
For instance, for investments in corporate bonds with no ratings restrictions, a risk weight of 150% must be applied.
Return to footnote 19
If the underlying is unknown, the full notional amount of derivative positions must be used for the calculation.
Return to footnote 20
If the notional amount of derivatives mentioned in paragraph 58 is unknown, it will be estimated conservatively using the maximum notional amount of derivatives allowed under the mandate.
Return to footnote 21
This corresponds to the highest add-on factor in the matrix included in Section 126.96.36.199 of Chapter 4 (i.e. as applied to derivative contracts with “Other Commodities” as underlying with a residual maturity over five years.
Return to footnote 22
For instance, if both replacement cost and PFE are unknown, a total multiplication factor of 1.15 is applied to the notional amount to reflect the CCR exposure.
Return to footnote 23
A bank is not required to apply the 1.5 factor for situations in which the CVA capital charge would not otherwise be applicable. This includes: (i) transactions with a central counterparty and (ii) securities financing transactions (SFTs), unless OSFI determines that the bank’s CVA loss exposure arising from SFTs is material.
Return to footnote 24
Securities Financing Transactions (SFT) are transactions such as repurchase agreements, reverse repurchase agreements, security lending and borrowing, and wholesale margin lending transactions, where the value of the transactions depends on the market valuations and the transactions are often subject to margin agreements.
Return to footnote 25
The counterparty credit risk is defined as the risk that the counterparty to a transaction could default before the final settlement of the transaction’s cash flows. An economic loss would occur if the transactions or portfolio of transactions with the counterparty has a positive economic value at the time of default. Unlike an institution’s exposure to credit risk through a loan, where the exposure to credit risk is unilateral and only the lending institution faces the risk of loss, the counterparty credit risk creates a bilateral risk of loss: the market value of the transaction can be positive or negative to either counterparty to the transaction. The market value is uncertain and can vary over time with the movement of underlying market factors.
Return to footnote 26
This does not include a spot transaction that is contracted to settle within the normal settlement period.
Return to footnote 27
See 3.4., “Forwards, Swaps, Purchased Options and Other Similar Derivatives”.
Return to footnote 28
These items are to be weighted according to the type of asset and not according to the type of counterparty with whom the transaction has been entered into.
Return to footnote 29
Written put options (where premiums are paid upfront) expressed in terms of market rates for currencies or financial instruments bearing no credit or equity risk are excluded from the framework.
Return to footnote 30
Gold contracts are treated the same as foreign exchange rate contracts for the purpose of calculating credit risk.
Return to footnote 31
For example, if a bank is owed both principal and interest, the assessment must fully take into account and reflect the credit risk associated with repayment of both principal and interest.
Return to footnote 32
However, when an exposure arises through a bank's participation in a loan that has been extended, or has been guaranteed against convertibility and transfer risk, by certain MDBs, its convertibility and transfer risk can be considered by national supervisory authorities to be effectively mitigated. To qualify, MDBs must have preferred creditor status recognised in the market and be included in Chapter 3. In such cases, for risk weighting purposes, the borrower's domestic currency rating may be used instead of its foreign currency rating. In the case of a guarantee against convertibility and transfer risk, the local currency rating can be used only for the portion that has been guaranteed. The portion of the loan not benefiting from such a guarantee will be risk-weighted based on the foreign currency rating.
Return to footnote 33
The notations follow the methodology used by Standard & Poor and by Moody’s Investors Service. The A-1 rating of Standard & Poor includes both A-1+ and A-1-.
Return to footnote 34
This category includes all non-prime and B or C ratings.
Return to footnote 35