Within the framework of the Capital Requirements Regulation III (CRR III), specifically in CRR III Article 113, requirements are established for institutions regarding the independent due diligence examination of counterparties. These requirements apply to all categories of loans and are designed to ensure the accurate assessment of credit risk.
According to CRR III, institutions are obligated to conduct a thorough due diligence examination of their counterparties at least once a year. The purpose of this examination is to scrutinize the risk profile and characteristics of the counterparties thoroughly. The examination ensures that external credit ratings alone are insufficient to accurately reflect the true credit risk profile of a counterparty.
If the due diligence examination reveals that the risk weight resulting from external credit ratings does not adequately reflect the actual risk profile, CRR III mandates that the risk weight for the respective position must be increased by at least one level. This means that the bank or financial institution must hold more capital as a buffer to cover the heightened credit risk.
The due diligence examination serves as an essential safeguard to ensure that banks and financial institutions conduct an appropriate and accurate assessment of their counterparties and establish capital requirements accordingly to account for potential losses adequately. This contributes to the stability of the financial system by ensuring that credit risk is assessed correctly, and sufficient capital is available to cover it.
