Under the Basel II framework, Standardized Approach for Credit Risk allows consideration of External Credit Ratings for the calculation of risk weighted assets/capital charge. This presentation provides an overview of the approach as prescribed for Indian Banking Industry by RBI.

1. External Ratings under the Basel
II framework
Aditya Lathe

2. Basel II FrameworkPart A
Calculation of Risk Weighted AssetsPart B
• Mapping of Risk Weights to Rating Scales
• Treatment of Off Balance Sheet Exposure
External Ratings - General GuidelinesPart C

3. Basel II Framework: Introduction


4. Basel II Framework : Indian Scenario
 Pillar I: Min CRAR for Banks in India set at 9%. Banks
encouraged to maintain Tier I CRAR of at least 6%.
 Pillar II: Banks to establish Internal Capital Adequacy
Assessment Process which shall be subject to rigorous
Supervisory Review Process.
 Pillar III: Public disclosures to enhance market transparency.
Among others, capital structure, capital adequacy, composition
of loan/credit portfolios by risk rating and detailed risk
parameters for each risk-rating category, market risk in
Trading Book, Interest rate risk in the Banking Book,
Operational risk etc to be disclosed.
 Banks in India to continue to have parallel run of Basel I &
Basel II till March 31, 2013, subject to review, and ensure that
their Basel II minimum capital requirement continues to be
higher than the prudential floor of 80% of the minimum capital
requirement computed as per Basel I framework for credit and
market risks.

5. Basel II Framework: Risk Measurement Approaches
Market Risk
Standardized
Approach
Alternative
Approach
Operational Risk
Basic Indicator
Approach
Standardized
Approach
Advanced
Measurement
Approach
Credit Risk
Standardized
Approach
Simple
Approach
Comprehensive
Approach
Foundation IRB
Approach
Advanced IRB
Approach

6. Credit Risk Measurement: Indian Scenario
 RBI mandate: All commercial banks in India required to adopt
Comprehensive Approach under the Standardised Approach for
measurement of Credit Risk.
 Foreign banks operating in India and Indian banks having
operational presence outside India migrated to this approach with
effect from March 31, 2008. All other commercial banks migrated
from March 31, 2009.
 RBI timeline for eventual migration to more advanced approaches for
Credit Risk measurement:
Approach Earliest date for
applying to RBI
Likely date of
approval by RBI
IRB Approach (Both
Foundation &
Advanced)
April 1, 2012 March 31, 2014

7. Credit Risk Measurement: Indian Scenario
 Credit Risk: Standardized Approach - Measurement of credit risk supported
by ratings assigned by eligible External Credit Rating Agencies (ECRAs)
 Eligible ECRAs as recognized by RBI:
Domestic Credit Rating Agencies
Credit Analysis and Research Limited
CRISIL Limited
FITCH India
ICRA Limited
Brickworks Rating India Pvt Ltd.
SMERA
International Credit Rating Agencies
Fitch
Moodys
Standard & Poor’s

8. Basel II FrameworkPart A
Calculation of Risk Weighted AssetsPart B
• Mapping of Risk Weights to Rating Scales
• Treatment of Off Balance Sheet Exposure
External Ratings - General GuidelinesPart C

9. Mapping of Risk Weights to Rating Scales
Risk Weight for claims on:
 Sovereigns - Domestic & Foreign
 Public Sector Enterprises - Domestic & Foreign
 Multilateral Agencies
 Banks- Domestic & Foreign
 Corporates - Domestic & Foreign
 Primary Dealers (PDs), Asset Finance Companies (AFCs), NBFCs,
Infrastructure Finance Companies (IFCs)
 Retail portfolio
 Loans secured by Residential Property (Housing Loans)
 Commercial Real Estate, Capital Market Exposure
 Non Performing Assets (NPAs)
 Others

10. Claims on Sovereigns - Domestic
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* Also applicable for exposure to RBI, DICGC, CGFTSI and loans under
Agriculture Debt Waiver Scheme 2008
** Also applicable for claims on ECGC
Exposure Type Risk Weight
All claims on GoI* 0%
Claims guaranteed by GoI 0%
Claims on State Govt. 0%
Claims guaranteed by State Govt.** 20%

11. Claims on Sovereigns - Foreign
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 Claims denominated in domestic currency of the
foreign sovereign, met out of the resources in the
same currency raised in the jurisdiction of that
sovereign to attract 0% risk weight.
Rating AAA AA A BBB BB B Below B Unrated
Risk
Weight
0% 0% 20% 50% 100
%
100
%
150% 100%

12. Claims on PSEs & Multilateral Agencies
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 Domestic PSE: Same Risk Weight as for Corporates
 Foreign PSEs:
 Claims on following multilateral agencies at flat rate of
20%
Rating AAA AA A BBB BB Below BB Unrated
Risk Weight 20% 20% 50% 100
%
100
%
150% 100%
Bank for International Settlements International Monetary Fund
World Bank Group Asian Development Bank
African Development Bank European Bank for Reconstruction &
Development
Inter-American Development Bank European Investment Bank
European Investment Fund Nordic Investment Bank
Caribbean Development Bank Islamic Development Bank
Council of Europe Development Bank

13. Claims on Banks - Domestic
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 Banks incorporated in India & branches of foreign
banks in India (All Scheduled Commercial Banks)
Level of CRAR Investment within 10% limit Other claims
9% and above Higher of 100 % or the risk weight as
per the rating of the instrument or
counterparty, whichever is higher
20%
6% to <9% 150% 50%
3% to <6% 250% 100%
0% to <3% 350% 150%
Negative 625% 625%

14. Claims on Banks - Foreign
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 Exposures of Indian branches of foreign banks,
guaranteed / counter-guaranteed by the overseas Head
Offices or the bank’s branch in another country would
amount to a claim on the parent foreign bank and would
also attract the risk weights as above
 However, claims on a bank denominated in 'domestic'
foreign currency met out of the resources in the same
currency raised in that jurisdiction, to be risk weighted at
20% provided the bank complies with the minimum
CRAR prescribed by the concerned bank regulator
Rating AAA AA A BB
B
BB B Below B Unrated
Risk
Weight
20% 20% 50% 50% 100% 100
%
150% 100%

15. Claims on Corporates - Domestic
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 Long Term Claims (Contractual maturity of above 1 year)
 Short Term Claims (Contractual maturity of 1 year and
below)
Where “+” or “-” notation is attached to the rating, the corresponding
main rating category risk weight to be used.
 Restructured / Re-scheduled Assets: Unrated standard /
performing claims to be assigned a risk weight of 125% until
satisfactory performance under the revised payment schedule
has been established for 1 year from the date when the first
payment of interest / principal falls due under the revised
schedule.
Rating AAA AA A BBB BB & Below Unrated
Risk
Weight
20% 30% 50% 100% 150% 100%
Rating A1+ A1 A2 A3 A4 A5 Unrated
Risk Weight 20% 30% 50% 100% 150% 150% 100%

16. Claims on Corporates: Foreign
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 Claim on an unrated corporate cannot be given a
risk weight preferential to that assigned to its
sovereign of incorporation.
Rating AAA AA A BBB BB Below
BB
Unrated
Risk
Weight
20% 20% 50% 100% 100% 150% 100%

17. Claims on PDs, AFCs, NBFCs, IFCs
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 Same as Risk Weight for Corporates - Domestic

18. Claims on Retail portfolio
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Qualifying Criteria for Retail:
 Orientation Criterion - The exposure is to an individual person or persons or
to a small business (where the total average annual turnover of last 3 years
is less than Rs. 50 crs)
 Product Criterion - The exposure is in the form of revolving credits and lines
of credit (including overdrafts), term loans and leases (e.g. instalment loans
and leases, student and educational loans) and small business facilities and
commitments.
 Granularity Criterion- Aggregate exposure to a single counterpart (or
business group) does not exceed 0.2 % of the overall regulatory retail
portfolio of the bank
 Low value of individual exposures - The maximum aggregated retail
exposure to a single counterpart does not exceed Rs. 5 crs
Notable Exclusions:
 Loans and Advances to bank’s own staff, fully covered by superannuation
benefits and / or mortgage of flat/ house;
 Consumer Credit, (including Personal Loans and credit card receivables)
 Housing Loans
Category All
Exposure
Risk Weight 75%

19. Claims on Loans secured by Residential Property
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
Amount of Loan Risk Weight
Upto Rs.30 Lakhs 50%
Above Rs. 30 Lakhs but below Rs.75 Lakhs 75%
Above Rs.75 Lakhs 125%
Amount of Loan Risk Weight
Upto Rs.75 Lakhs 100%
Above Rs.75 Lakhs 125%

20. Claims on CRE & Capital Market Exposure
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Commercial Real Estate:
 The funding results in creation or acquisition of real estate (such as, office
buildings to let, retail space, multifamily residential buildings, industrial or
warehouse space, and hotels)
 The prospects for repayment depend primarily on cash flows generated by
the asset. Prospect of recovery in event of default also depend primarily on
the cash flows generated from the funded asset.
Capital Market Exposure:
 Direct investment in capital markets,
 Advance against capital market instruments, or on clean basis to individuals
for investment in capital market instruments
 Advances for any other purpose where capital market instruments are taken
as primary security.
(For detailed guidelines, consult References)
Category Risk Weight
Commercial Real Estate 100%
Capital Market Exposure 125%

21. Claims on Non Performing Assets
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 For defining secured portion of NPA, eligible
collateral will be the same as recognised for credit
risk mitigation purposes (Cash, Gold, Securities
issued by Central or State Govt, KVP, NSC, Life
Insurance Policies, Debt securities rated by a Credit
Rating Agency, Units of MFs). Other forms of
collateral like land, buildings, plant, machinery,
current assets, etc. not allowable for capital
adequacy purposes.
Unsecured portion of NPA, where specific provisions are Risk Weight
Less than 20% of outstanding 150%
At least 20% of outstanding 100%
At least 50% of outstanding 50%

22. Claims on Others
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Category Risk Weight
High Risk Venture Capital Funds 150%
Consumer Credit (Personal loans, credit card receivables) 125%
Non-deposit Taking Systemically Important Non-Banking
Financial Companies (NBFC-ND-SI),
100%
All investments in the paid up equity of non-financial entities,
which are not consolidated for capital purposes with the bank
125%
Loans and advances to bank’s own staff which are fully
covered by superannuation benefits and/or mortgage of flat/
house
20%

23. Treatment of Off Balance Sheet Exposure
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Off Balance
Sheet Exposure
-Market Related
-Non Market Related
• Notional Exposure
Credit
Equivalent
Exposure
• Notional Exposure X CCF
Risk Weighted
Asset • CEE X Risk Weight

24. Off Balance Sheet Exposure- Non- Market related
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Instrument CCF
Direct credit substitutes and acceptances, where the risk of loss depends
on the credit worthiness of the counterparty or the party against whom a
potential claim is acquired
(eg. standby L/Cs serving as financial guarantees for loans and
securities, credit enhancements, liquidity facilities for securitisation
transactions etc.)
100%
Transaction-related contingent items
(e.g. performance bonds, bid bonds, warranties, indemnities and standby
letters of credit related to particular transaction).
50%
Short-term self-liquidating trade letters of credit arising from the
movement of goods for both issuing bank & confirming bank.
(e.g. documentary credits collateralised by the underlying shipment)
20%
Sale & repurchase agreements, and asset sales with recourse, where the
credit risk remains with the bank.
100%
Forward asset purchases, forward deposits and partly paid shares and
securities, which represent commitments with certain drawdown.
100%

25. Off Balance Sheet Exposure- Non- Market related
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Instrument CCF
Lending of banks’ securities or posting of securities as collateral by
banks, including instances where these arise out of repo style
transactions
100%
Note issuance facilities and underwriting facilities. 50%
Commitments with certain drawdown 100%
Other commitments (e.g., formal standby facilities and credit lines) with
an original maturity of
a) up to 1 year
b) over 1 year.
Commitments that are unconditionally cancellable at any time by the
bank without prior notice or that effectively provide for automatic
cancellation due to deterioration in a borrower’s credit worthiness
20%
50%
0%
Take-out Finance in the books of taking-over institution
(i) Unconditional take-out finance
(ii) Conditional take-out finance
100%
50%

26. Off Balance Sheet Exposure- Non Market related
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Following transactions to be treated as claims on
banks:
 Guarantees issued by banks against the counter
guarantees of other banks.
 LCBD Cases: Rediscounting of documentary bills
discounted by other banks, and bills discounted by
banks which have been accepted by another bank

27. Off Balance Sheet Exposure- Market related
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Market related off-balance sheet items
 Interest Rate Contracts – single currency interest rate
swaps, basis swaps, forward rate agreements, and
interest rate futures;
 Foreign Exchange Contracts - contracts involving gold,
cross currency swaps, cross currency interest rate
swaps, forward foreign exchange contracts, currency
futures, currency options
 Any other market related contracts specifically allowed by
RBI which gives rise to credit risk.
Does not include foreign exchange (except gold) contracts
which have an original maturity of 14 calendar days or less;
and instruments traded on futures and options exchanges
which are subject to daily mark-to-market and margin
payments.

28. Off Balance Sheet Exposure- Market related
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CCF Calculation: Current Exposure Method:
 Credit Equivalent Amount = Current Credit Exposure + Potential Future
Exposure
 Current Credit Exposure is sum of positive mark-to-market value of
contracts
 Potential Future Exposure determined by multiplying notional
principal amount of the contract with following CCF:
Maturity CCF
Interest Rate
Contracts
Exchange Rate Contracts &
Gold
1 year or less 0.50% 2.00%
Over 1 year to 5
years
1.00% 10.00%
Over 5 years 3.00% 15.00%

29. Basel II FrameworkPart A
Calculation of Risk Weighted AssetsPart B
• Mapping of Risk Weights to Rating Scales
• Treatment of Off Balance Sheet Exposure
External Ratings - General GuidelinesPart C

30. External Ratings - General Guidelines
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Publicly available ratings:
 Only publically available credit assessments to be
used. (i.e. rating must be published in an accessible
form and included in the external credit rating
agency’s transition matrix). Ratings made available
only to the parties to a transaction are ineligible.
Currently Valid ratings:
 Only ratings currently in force and confirmed from
the monthly bulletin of the concerned rating agency
to be used. The rating agency should have reviewed
the rating at least once during the previous 15
months.

31. External Ratings - General Guidelines
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Unsolicited ratings:
 Banks to use only solicited ratings. A rating is
solicited only if the issuer of the instrument has
requested the credit rating agency for the rating and
has accepted the rating assigned by the agency.
Cherry Picking
 Banks not allowed to use one agency’s rating for one
exposure, while using another agency’s rating for
another exposure to the same counter-party, unless
the respective exposures are rated by only one of
the chosen credit rating agencies, whose ratings the
bank has decided to use.

32. External Ratings - General Guidelines
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Multiple Ratings:
 In case of divergent ratings from two different ECRAs,
rating with higher risk weight to be used.
 In case of divergent ratings from three or more different
ECRAs, ratings corresponding to the two lowest risk
weights to be considered and the higher of those two risk
weights to be applied. i.e., the second lowest risk weight.
Double Counting of Credit Mitigants
 To avoid double counting of credit enhancement factors,
credit risk mitigation techniques should not be taken into
account if the credit enhancement is already reflected in
the rating.

33. External Ratings - General Guidelines
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Application of Issue Rating to unrated claims
 Sort-term ratings are issue-specific. Cannot be
generalised to other short-term claims or long-term
claims.
 In cases where the Bank’s exposure is not a part of the
rated exposure of the borrower, the long term rating of
the rated exposure may be applied to the bank’s un-
assessed claim if this claim ranks pari passu or senior to
the specific rated exposure in all respects and the
maturity of the un-assessed claim is not later than the
maturity of the rated claim.
Note: Substitution of Foreign currency ratings only for
exposures in foreign currency.

34. External Ratings - General Guidelines
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Higher weightage to unrated claims
 In case an issuer has long-term/ short-term exposure
with rating that has a risk weight of 150%, all unrated
claims to also receive a 150% risk weight.
 Short Term Claims: Unrated short term claim to
attract a risk weight of at least one level higher than
the risk weight applicable to the rated short term
claim on that counter-party. (Eg. If a short-term rated
facility attracts a 20% or 50% risk-weight, unrated
short-term claims to the same counter-party cannot
attract a risk weight lower than 30% or 100%
respectively).

35. External Ratings - General Guidelines
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Substitution of guarantor’s rating: Guaranteed portion of the counterparty
exposure to be assigned risk weight of the guarantor, whereas the uncovered
portion to retain the risk weight of the underlying counterparty. Substitution of
risk weight is allowable in cases where available guarantee meets the following
criteria:
 Direct & Explicit: The guarantee must represent a direct claim on the
protection provider and must be explicitly referenced to specific exposures or
a pool of exposures, so that extent of the cover is clearly defined and
incontrovertible.
 Irrevocable: The guarantee must be irrevocable; there must be no clause in
the contract that would allow the protection provider unilaterally to cancel the
cover or that would increase the effective cost of cover as a result of
deteriorating credit quality in the guaranteed exposure.
 Unconditional: The guarantee must be unconditional; there should be no
clause in the guarantee outside the direct control of the bank that could
prevent the protection provider from being obliged to pay out in a timely
manner in the event that the original counterparty fails to make the payment
due.

36. External Ratings - General Guidelines
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Eligible Guarantors: (i) Sovereigns, sovereign entities
(including BIS, IMF, European Central Bank and European
Community as well as other mentioned Multilateral
Agencies; banks and primary dealers with a lower risk
weight than the counterparty
(ii) other entities rated AA- or better. (including parent,
subsidiary and affiliate companies when they have a lower
risk weight than the obligor). Rating of the guarantor should
be an entity rating which has factored in all the liabilities
and commitments (including guarantees) of the entity.
 No adjustment permitted on account of guarantees in
case of NPAs.

37. Capital Saving: Unconditional Cancellability Clause
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 Undrawn portion of CC limit: Non market Off Balance Sheet exposure arises on
account of maximum unused portion of the commitment that could be drawn during
the remaining period to maturity.
 Example: Sanctioned CC Limits: Rs. 100 crs
Company Rating : A
Facilities not unconditionally cancellable
Details Amount
(A)
CCF
(B)
Risk Weight
(C)
RWA
(A*B*C)
Cash Credit Facility Rs. 100 crs - - -
Drawn Portion Rs.60 crs NA 50% Rs.30 crs
Undrawn Portion Rs.40 crs 20% 50% Rs.4 crs
Total Rs.34 crs

38. Capital Saving: Project Sequencing
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 Commitments with certain drawdown:
 Example: Sanctioned Term Loan: Rs.1000 crs
Drawdown Period : 3 Years (Bank’s explicit approval needed for each drawdown)
Stage I : Amount- Rs.200 crs, Time period of execution-1 year
Stage II : Amount- Rs.300 crs, Time period of execution- 1.5 years
Stage III : Amount- Rs. 500 crs, Time period of execution- 2 years
Company Rating : A
Details Amount
(A)
CCF
(B)
Risk Weight
(C)
RWA
(A*B*C)
Term Loan Facility Rs. 1000 crs - - -
Amount for Stage I Rs.200 crs - - -
Drawn Portion Rs.150 crs NA 50% Rs.75 crs
Undrawn Portion Rs.50 crs 20% 50% Rs.5 crs
Total Rs.80 crs

39. Thank You

40. References
Documents Consulted
 International Convergence of Capital Measurement
and Capital Standards – A Revised Framework
(June 2006) (Source)
 RBI Master Circular on Prudential Guidelines on
Capital Adequacy and Market Discipline-
Implementation of New Capital Adequacy
Framework (July 2011) (Source)
 RBI Guideline on Classification of Exposures as
CRE (Sep 2009) (Source)
 RBI Master Circular on Exposure Norms (July 2011)
(Source)