Amendments to the " Methods for Calculating Bank’s Regulatory Capital and Risk-Weighted Assets" shall soon be promulgated to strengthen the risk management framework of domestic banks
2023-11-21
To strengthen the risk management framework of domestic banks, the Financial Supervisory Commission (hereinafter referred to as the FSC) will soon promulgate the " Methods for Calculating Bank’s Regulatory Capital and Risk-Weighted Assets" (hereinafter referred to as the Methods) which are amended in accordance with international financial supervisory standards. The amendments will become effective on January 1, 2025 to provide banks with sufficient time for adjustments. To enhance the internal risk management capabilities of banks, the FSC will also allow banks to apply for the adoption of the internal ratings-based (IRB) approach for credit risk to calculate the capital.
In the wake of the financial crisis of 2008, the Basel Committee on Banking Supervision (BCBS) published the " Basel III: A global regulatory framework for more resilient banks and banking systems" and proposed reforms for strengthening global capital standards in December 2010 to increase the resilience of banks in response to economic impacts and support the stability of the banking system and economic development. To ensure that domestic banks establish a risk management framework consistent with international standards, the FSC has implemented the aforementioned Basel III framework since 2013 and adopted liquidity coverage ratio requirements since 2015, aligning with international liquidity standards. Additionally, to address the lack of risk sensitivity and other vulnerabilities of banks exposed in the financial crisis, the BCBS published the " Basel III: Finalising post-crisis reforms" (hereinafter referred to as the Reforms) on December 7, 2017. Due to the impact of the pandemic, the BCBS announced in March 2020 the postponement of the implementation to 2023. The FSC originally planned to implement the amendments to the standardized approach for credit risk, IRB approach, operational risk, leverage ratio, and output floor in the Reforms starting from January 1, 2024. On the other hand, the FSC planned to implement the revisions of the counterparty credit valuation adjustment (CVA) framework, minimum capital requirements for market risk, and securitization exposure capital calculation standards starting from January 1, 2025. However, considering the international trend of postponing the implementation of the Reforms and taking the need for domestic banks to adjust their systems and internal operations into account, the FSC decided to implement all aforementioned revised regulations from January 1, 2025, to give banks sufficient time for adjustments.
The contents of the amendments include the standardized approach for credit risk, IRB approach, output floor, operational risk, and leverage ratio. The key points of the amendments are as follows:
1. Standardized approach for credit risk:
(1) The FSC enhanced the risk sensitivity of capital calculation for credit risk and refined the risk exposure classification and corresponding risk weights. The FSC amended the risk weights to corporate exposures, equity exposures, and retail exposures and the credit conversion factors of off-balance sheet items. The risk weights of equity exposures will be increased based on a five-year linear phase-in arrangement.
(2) The FSC added regulations for due diligence, which require banks that use external credit ratings to calculate capital conduct reviews at least once every year to strengthen banks' accountability for using external credit ratings. The FSC also specified the definitions of defaulted exposures and amended related regulations for credit risk mitigation techniques. Moreover, the FSC referenced the BCBS Q&A and amended related regulations on the standardized approach for counterparty credit risk.
2. IRB approach: The amendment is mainly based on the Reforms with adjustments according to banking practices, including the exclusion of exposures to which the IRB approach does not apply (e.g., equity exposures), adjustments of the minimum estimates of risk components (probability of default, loss given default, exposure at default), improvement of the internal model validation framework, and establishment of the model calibration process. The FSC also adjusted the qualifications and procedures of application for banks, including changing the pilot program duration from 2 years to 1 year. Banks shall issue related audit reports after the pilot program, obtain approval from the board of directors, and submit them to the FSC.
3. New output floor regulations: To enhance the credibility and comparability of capital calculation, it is required that risk-weighted assets (RWA) calculated by banks under the IRB approach shall be at least 72.5% of those calculated under the standardized approach. If the ratio is lower than 72.5%, the capital shall be calculated based on 72.5% of the RWA calculated under the standardized approach.
4. Operational risk: The main amendment is the revised method for calculating capital for operational risk, which is changed from the current "basic indicator approach," "standardized approach," and "advanced measurement approach" to the "new standardized approach."
5. Leverage ratio: The main adjustment is the improvement of the exposure measurement of leverage ratio, such as the amendment of the calculation of derivative exposures and the new regulations on the treatment of clearing services.
The FSC has requested 38 domestic banks to perform calculations on the basis of their individual capital adequacy ratios as of the end of December 2022. According to the results of the calculation, the average common equity tier 1 ratio, tier 1 capital ratio, and total capital adequacy ratio of all banks decreased only slightly (by 0.24%, 0.28%, and 0.31%, respectively) after the amendment, and the average leverage ratio remained unchanged. Overall, the amendment of the capital calculation has little impact on domestic banks. As for other regulations in the Reforms, including CVA framework, minimum capital requirements for market risk, and securitization exposure capital calculation standards, the draft versions will be released before the second quarter of 2024.
To enhance banks' internal risk management capability and adoption of more precise methods to measure and manage credit risk and credit assets, the FSC will allow banks to apply for the use of the IRB approach for credit risk to calculate capital. Banks that meet the criteria for having assets over NT$2.5 trillion, financial soundness, and compliance may file an application to the FSC. The FSC states that the application deadline for the first batch shall be the end of June 2024, and will soon announce the application documents and related information.
As the capital adequacy ratio is an important indicator for measuring a bank's risk-bearing capacity, the FSC shall continue to refer the international regulations published by the BCBS and the practices of major countries to discuss and propose amendments for domestic regulations on the capital adequacy ratio while ensuring both consistency with international standards and the principles of robustness and feasibility.
In the wake of the financial crisis of 2008, the Basel Committee on Banking Supervision (BCBS) published the " Basel III: A global regulatory framework for more resilient banks and banking systems" and proposed reforms for strengthening global capital standards in December 2010 to increase the resilience of banks in response to economic impacts and support the stability of the banking system and economic development. To ensure that domestic banks establish a risk management framework consistent with international standards, the FSC has implemented the aforementioned Basel III framework since 2013 and adopted liquidity coverage ratio requirements since 2015, aligning with international liquidity standards. Additionally, to address the lack of risk sensitivity and other vulnerabilities of banks exposed in the financial crisis, the BCBS published the " Basel III: Finalising post-crisis reforms" (hereinafter referred to as the Reforms) on December 7, 2017. Due to the impact of the pandemic, the BCBS announced in March 2020 the postponement of the implementation to 2023. The FSC originally planned to implement the amendments to the standardized approach for credit risk, IRB approach, operational risk, leverage ratio, and output floor in the Reforms starting from January 1, 2024. On the other hand, the FSC planned to implement the revisions of the counterparty credit valuation adjustment (CVA) framework, minimum capital requirements for market risk, and securitization exposure capital calculation standards starting from January 1, 2025. However, considering the international trend of postponing the implementation of the Reforms and taking the need for domestic banks to adjust their systems and internal operations into account, the FSC decided to implement all aforementioned revised regulations from January 1, 2025, to give banks sufficient time for adjustments.
The contents of the amendments include the standardized approach for credit risk, IRB approach, output floor, operational risk, and leverage ratio. The key points of the amendments are as follows:
1. Standardized approach for credit risk:
(1) The FSC enhanced the risk sensitivity of capital calculation for credit risk and refined the risk exposure classification and corresponding risk weights. The FSC amended the risk weights to corporate exposures, equity exposures, and retail exposures and the credit conversion factors of off-balance sheet items. The risk weights of equity exposures will be increased based on a five-year linear phase-in arrangement.
(2) The FSC added regulations for due diligence, which require banks that use external credit ratings to calculate capital conduct reviews at least once every year to strengthen banks' accountability for using external credit ratings. The FSC also specified the definitions of defaulted exposures and amended related regulations for credit risk mitigation techniques. Moreover, the FSC referenced the BCBS Q&A and amended related regulations on the standardized approach for counterparty credit risk.
2. IRB approach: The amendment is mainly based on the Reforms with adjustments according to banking practices, including the exclusion of exposures to which the IRB approach does not apply (e.g., equity exposures), adjustments of the minimum estimates of risk components (probability of default, loss given default, exposure at default), improvement of the internal model validation framework, and establishment of the model calibration process. The FSC also adjusted the qualifications and procedures of application for banks, including changing the pilot program duration from 2 years to 1 year. Banks shall issue related audit reports after the pilot program, obtain approval from the board of directors, and submit them to the FSC.
3. New output floor regulations: To enhance the credibility and comparability of capital calculation, it is required that risk-weighted assets (RWA) calculated by banks under the IRB approach shall be at least 72.5% of those calculated under the standardized approach. If the ratio is lower than 72.5%, the capital shall be calculated based on 72.5% of the RWA calculated under the standardized approach.
4. Operational risk: The main amendment is the revised method for calculating capital for operational risk, which is changed from the current "basic indicator approach," "standardized approach," and "advanced measurement approach" to the "new standardized approach."
5. Leverage ratio: The main adjustment is the improvement of the exposure measurement of leverage ratio, such as the amendment of the calculation of derivative exposures and the new regulations on the treatment of clearing services.
The FSC has requested 38 domestic banks to perform calculations on the basis of their individual capital adequacy ratios as of the end of December 2022. According to the results of the calculation, the average common equity tier 1 ratio, tier 1 capital ratio, and total capital adequacy ratio of all banks decreased only slightly (by 0.24%, 0.28%, and 0.31%, respectively) after the amendment, and the average leverage ratio remained unchanged. Overall, the amendment of the capital calculation has little impact on domestic banks. As for other regulations in the Reforms, including CVA framework, minimum capital requirements for market risk, and securitization exposure capital calculation standards, the draft versions will be released before the second quarter of 2024.
To enhance banks' internal risk management capability and adoption of more precise methods to measure and manage credit risk and credit assets, the FSC will allow banks to apply for the use of the IRB approach for credit risk to calculate capital. Banks that meet the criteria for having assets over NT$2.5 trillion, financial soundness, and compliance may file an application to the FSC. The FSC states that the application deadline for the first batch shall be the end of June 2024, and will soon announce the application documents and related information.
As the capital adequacy ratio is an important indicator for measuring a bank's risk-bearing capacity, the FSC shall continue to refer the international regulations published by the BCBS and the practices of major countries to discuss and propose amendments for domestic regulations on the capital adequacy ratio while ensuring both consistency with international standards and the principles of robustness and feasibility.
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2023-12-21