They are critical to reduce risk weights under the revised standardized approach for high rated corporates and banks.
Corporates: For corporate exposures, base risk weights are to be assigned as per the table below2.
2 The presumption being that European banks fall under the jurisdiction which allows the use of external ratings for regulatory purposes. Consequently, an “investment grade” indicator would not be significant for data requirements.
External rating of counterparty
AAA to AA–
A+ to A–
BBB+ to BBB–
BB+ to BB–
“Base” risk weight
The differences between Basel III and Basel IV regulations are captured in bucket 3 above (BBB+ to BBB-), where the risk weights have been reduced from 100% to 75%. The majority of the current Corporate exposures for European banks would qualify for this bracket with risk weights ranging between 90% to 100%.
Therefore, it is extremely important for banks to ensure that the respective business entities maintain the external ratings information accurately.
Banks and Financial Institutions: In addition to the External Credit Risk Assessment Approach (ECRA), a Standardized Credit Risk Assessment Approach (SCRA) has been defined and can be particularly applicable for unrated bank exposures (while the rated bank exposures comply with the ECRA approach). More granularity has been added for the risk weight buckets, and it would be prudent for banks to source accurate and complete external ratings for their bank/FI exposures.
Additionally, external ratings would be relevant for banks following the IRB approach for their portfolios since now they have to benchmark their RWA with the output floor.