Standardized approach (credit risk)

The term standardized approach (or standardised approach) refers to a set of credit risk measurement techniques proposed under Basel II capital adequacy rules for banking institutions.

Under this approach the banks are required to use ratings from External Credit Rating Agencies to quantify required capital for credit risk. In many countries this is the only approach the regulators are planning to approve in the initial phase of Basel II Implementation.

The Basel Accord proposes to permit banks a choice between two broad methodologies for calculating their capital requirements for credit risk. The other alternative is based on internal ratings.

The summary of risk weights in standardized approach

There are some options in weighing risks for some claims, below are the summary as it might be likely to be implemented.

NOTE: For some "unrated" risk weights, banks are encouraged to use their own internal-ratings system based on Foundation IRB and Advanced IRB in Internal-Ratings Based approach with a set of formulae provided by the Basel-II accord. There exist several alternative weights for some of the following claim categories published in the original Framework text.

• Claims on sovereigns

• Claims on the BIS, the IMF, the ECB, the EC and the MDBs

Risk Weight: 0%

• Claims on banks and securities companies

Related to assessment of sovereign as banks and securities companies are regulated.

• Claims on corporates

• Claims on retail products

This includes credit card, overdraft, auto loans, personal finance and small business.

Risk weight: 75%

• Claims secured by residential property

Risk weight: 35%

• Claims secured by commercial real estate

Risk weight: 100%

• Overdue loans

more than 90 days other than residential mortgage loans.

Risk weight:

150% for provisions that are less than 20% of the outstanding amount

100% for provisions that are between 20% - 49% of the outstanding amount

100% for provisions that are no less than 50% of the outstanding amount, but with supervisory discretion are reduced to 50% of the outstanding amount

• Other assets

Risk weight: 100%

• Cash

Risk weight: 0%

See also

• Foundation IRB
• Advanced IRB
• Credit risk
• Basel II

References

• Basel II: Revised international capital framework (BCBS)
• Basel II: International Convergence of Capital Measurement and Capital Standards: a Revised Framework (BCBS)
• Basel II: International Convergence of Capital Measurement and Capital Standards: a Revised Framework (BCBS) (November 2005 Revision)
• Basel II: International Convergence of Capital Measurement and Capital Standards: a Revised Framework, Comprehensive Version (BCBS) (June 2006 Revision)