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Basel working group suggests "pragmatic" approach to credit risk expected losses

BASEL - A working group of the Basel Committee of banking supervisors has proposed "a pragmatic approach" to treating expected losses in arriving at a capital charge for credit risk under the internal ratings based (IRB) approach of the proposed Basel II banking accord.

    • David Keefe
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The Basel Committee noted that the IRB approach as outlined in its January consultative paper on Basel II entails capital charges being calibrated to cover both unexpected and expected credit losses in loan portfolios.

The Committee said the capital charge for unexpected losses (UL) is uncontroversial, but the banking industry's reaction to a capital charge for expected losses (EL) is generally negative.

In a paper issued in July, the Committee's Joint Accounting Task Force/Models Task Force Working Group suggests capital requirements should continue to be calibrated toward UL and EL, albeit in combination with a recognition of provisions actually made and, for the retail portfolio, also of the future margin income.

Under this approach the capital requirements for UL and EL would be allowed to be met by the sum of capital, specific provisions, general loan loss provisions not included in capital, and possible future margin income. The combined contribution of the last three elements would be capped at the EL element of the capital requirement.

Basel Committee Working Papers: IRB Treatment of Expected losses and Future Margin Income available on the Bank for International Settlements' website: www.bis.org.Operational Risk

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