UK Basel 3.1: Credit risk standardised approach – exposures to corporates
On 12 September 2024, the Prudential Regulation Authority (PRA) published the second part of its near-final rules on the implementation of Basel 3.1 standards through Policy Statement 9/24 (PS9/24) which offers feedback on the responses received on Consultation Paper 16/22 (CP16/22) published on 30 November 2022.
PS9/24 covers inter alia the near-final rules on credit risk, disclosures, and reporting as well as minor clarifications and corrections to the previous near-final rules published within PS17/23. The implementation date for Basel 3.1 standards has also been postponed to 1 January 2026.
A summary of the changes relating to ‘corporate exposures’ under the credit risk standardised approach is provided below.
Key changes to exposures to corporates, under the standardised approach, include:
Infrastructure and Small- and Medium-sized Enterprise (SME) support factors will be removed. To replace the SME support factor, a reduced risk weight of 85% has been proposed for unrated corporate SMEs.
New definition of ‘SME’: annual turnover < GBP 44 million; at highest consolidation; and any legal form of the enterprise.
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 credit risk of the counterparty, 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' class. 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. (See Appendix 1 in our Overview article.)
A summary of the revised classifications and applicable risk weights is given below:
Existing and revised Risk Weights
^ Only applicable to exposures to corporates, institutions, and covered bonds
Due diligence requirements include:
Monitoring counterparties
Proportionate due diligence process
Frequency – at inception and annually thereafter
Granularity – at the level of individual exposure (if practical)
Understand risk profiles
Assess the operating and financial condition
Consider group structure and counterparty
Ensure effective systems to assign correct risk-weighted exposure to an obligor
Regular access to information for due diligence
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%.
How We Can Help
Banks may face a variety of challenges when preparing for Basel 3.1. At Katalysys, we have a deep understanding of prudential regulatory requirements both from the perspective of rules and practical implementation. Our team is already supporting a range of clients in this area, and includes:
Workshops or training to cover new requirements.
Gap and impact analyses.
Guidance on implementing industry best-practice in relation to the Basel 3.1 standards.
Documenting or updating assumptions and interpretations in regulatory reporting.
Preparation of regulatory reporting policies and procedure notes.
Validation of the system outputs and calculations.
Review of regulatory returns, including post-implementation of Basel 3.1 changes.
For more information, please contact:
Josh Nowak
Managing Director, Risk & Regulatory Consulting
T: +44 (0)7587 720 988
Manish Patidar
Director, Regulatory Consulting
T: +44 (0)7766 001 643