Basel III update: New risk assessment against institutions without a credit assessment by a designated ECAI

The European Union plans to use the revised Basel III standards to change the current treatment of exposures to institutions that do not have a credit assessment from a designated ECAI. The final decision is to be taken in June 2023, with a view to introducing new Basel III standards for exposures to institutions in 2025. Banks therefore need to prepare for the new Basel III standards to ensure that they remain compliant with the updated rules. We are already working to implement these new requirements in FinAPU by autumn 2023.

Current assessment

Currently, exposures to institutions that do not have a credit assessment from a designated ECAI are assigned a risk weight according to the credit quality step assigned to exposures to the central government in whose jurisdiction the institution is incorporated, according to a table.

In future: 3-step model 

The new approach requires institutions to classify their exposures to these institutions into one of three tiers based on a number of quantitative and qualitative criteria. The new approach aims to break the link between institutions and their states.

Level A 

• the institution has sufficient capacity to meet its financial obligations over the projected term of the loan 
• the institution meets or exceeds the relevant requirements with common equity tier 1 capital, tier 1 capital or owner’s equity 
• information about the stated requirements is published or otherwise made available and the result of the due diligence process does not contradict this 

Level B 

• the institution is subject to significant credit risk, with repayment capacities dependent, among other things, on a stable or favorable economic or business environment
• the institution meets or exceeds the relevant requirements with common equity tier 1 capital, tier 1 capital or owner’s equity
• information about the stated requirements is published or otherwise made available and the result of the due diligence process does not contradict this

Level C 

• the institution has significant default risks and limited safety margins 
• adverse corporate, financial or economic conditions are very likely to result or have caused the institution to be unable to meet its financial obligations 
• the external auditor has issued an unfavorable opinion or, within the last 12 months, has raised significant doubts in its financial statements or audited reports as to the institution's ability to continue as a going concern

The following risk assessments will apply in the future:

These new classifications result in a risk score equal to the risk weights for short positions and risk weights for long positions. It is ensured that the creditworthiness of the institutions' counterparties is reflected appropriately and conservatively in the own funds requirements, regardless of whether the exposures are backed by an external credit rating or not. 

In order to avoid a mechanistic application of the criteria, institutions are also subject to the due diligence requirements of Article 79 CRD in relation to exposures to institutions for which a credit assessment by a nominated ECAI is available when assigning the applicable risk weight. This ensures that the creditworthiness of institutions' counterparties is appropriately and conservatively reflected in the own funds requirements, regardless of whether the exposures are externally rated or not. In line with Basel III standards, the current option to risk weight exposures to institutions based on the credit rating of their sovereigns will be removed in order to de-link institutions and their sovereigns. 

FinAPU is planning an update on this topic in autumn 2023 when further details are available.