Back Custom print Link Text Only Rich Text Print

  • (ii) PD/LGD Approach

    • CA-5.5.12

      The minimum requirements and methodology for the PD/LGD approach for equity exposures (including equity of companies that are included in the retail asset class) are the same as those for the IRB foundation approach for corporate exposures subject to the following specifications:

      (a) The bank's estimate of the PD of a corporate entity in which it holds an equity position must satisfy the same requirements as the bank's estimate of the PD of a corporate entity where the bank holds debt.46 If a bank does not hold debt of the company in whose equity it has invested, and does not have sufficient information on the position of that company to be able to use the applicable definition of default in practice but meets the other standards, a 1.5 scaling factor will be applied to the risk weights derived from the corporate risk-weight function, given the PD set by the bank. If, however, the bank's equity holdings are material and it is permitted to use a PD/LGD approach for regulatory purposes but the bank has not yet met the relevant standards, the simple risk-weight method under the market-based approach will apply;
      (b) An LGD of 90% would be assumed in deriving the risk weight for equity exposures; and
      (c) For these purposes, the risk weight is subject to a five-year maturity adjustment whether or not the bank is using the explicit approach to maturity elsewhere in its IRB portfolio.

      46 In practice, if there is both an equity exposure and an IRB credit exposure to the same counterparty, a default on the credit exposure would thus trigger a simultaneous default for regulatory purposes on the equity exposure.

      Amended: April 2011
      Apr 08

    • CA-5.5.13

      Under the PD/LGD approach, minimum risk weights as set out in section CA-5.5.14 and CA-5.5.15 apply. When the sum of UL and EL associated with the equity exposure results in less capital than would be required from application of one of the minimum risk weights, the minimum risk weights must be used. In other words, the minimum risk weights must be applied, if the risk weights calculated according to the preceding paragraph plus the EL associated with the equity exposure multiplied by 12.5 are smaller than the applicable minimum risk weights.

      Apr 08

    • CA-5.5.14

      A minimum risk weight of 100% applies for the following types of equities for as long as the portfolio is managed in the manner outlined below:

      (a) Public equities where the investment is part of a long-term customer relationship, any capital gains are not expected to be realised in the short term and there is no anticipation of (above trend) capital gains in the long term. It is expected that in almost all cases, the institution will have lending and/or general banking relationships with the portfolio company so that the estimated probability of default is readily available. Given their long-term nature, specification of an appropriate holding period for such investments merits careful consideration. In general, it is expected that the bank will hold the equity over the long term (at least five years); and
      (b) Private equities where the returns on the investment are based on regular and periodic cash flows not derived from capital gains and there is no expectation of future (above trend) capital gain or of realising any existing gain.
      Amended: April 2011
      Apr 08

    • CA-5.5.15

      For all other equity positions, including net short positions (as defined in section CA-5.5.7), capital charges calculated under the PD/LGD approach may be no less than the capital charges that would be calculated under a simple risk weight method using a 200% risk weight for publicly traded equity holdings and a 300% risk weight for all other equity holdings.

      Apr 08

    • CA-5.5.16

      The maximum risk weight for the PD/LGD approach for equity exposures is 1250%. This maximum risk weight can be applied, if risk weights calculated according to section CA-5.5.12 plus the EL associated with the equity exposure multiplied by 12.5 exceed the 1250% risk weight. Alternatively, banks may deduct the entire equity exposure amount, assuming it represents the EL amount, 50% from Tier 1 capital and 50% from Tier 2 capital.

      Apr 08

    • CA-5.5.17

      Hedging for PD/LGD equity exposures is, as for corporate exposures, subject to an LGD of 90% on the exposure to the provider of the hedge. For these purposes equity positions will be treated as having a five-year maturity.

      Apr 08