RBA Annual Conference – 2008 The Sub-prime Crisis: Causal Distortions and Regulatory Reform

Table 2: Basel and Basel II Risk Weights and Commentary
Selected risk weights under Basel I and Basel II (Pillar 1); per cent
Security Basel I Basel II Basel II advanced: internal ratings-based (IRB) for the United States
Simplified,
standardised		 Standardised based on
external ratings		 2004–05 QIS-4
Average percentage
change in portfolio MRC 		2004–05 QIS-4
Median percentage
change in portfolio MRC 		Commentary
Most government/central banks 0 0       0 0 Comes close to letting banks set their own Pillar 1 capital, with supervisory oversight. Risk weights depend on internal estimates of a loan's probability of default; loss given default; and exposure to loss. These are based on the banks' own complex risk models, relying on subjective inputs and often on unobservable (e.g. OTC illiquid securities) prices.

Pillar 2 provides for supervisory oversight. With stress testing, and guidance from supervisors, banks can be made to hold capital for risks not adequately captured under Pillar 1.

Pillar 3 is disclosure and market discipline which relies on some notion of market efficiency. Rational markets punish poor risk managers.
AAA to AA−     0        
A+ to A−     20        
BBB+ to BBB−     50        
BB+ to B− (& unrated)     100        
Below B−     150        
Other public (supervisors' discretion) 0–50 0       0 0
Claims on MDBs 20 0       −21.9 −29.7
Most OECD banks & securities firms 20 20 <90 days Other   −21.9 −29.7
AAA to AA−     20 20      
A+ to A−     20 50      
BBB+ to BBB− (& unrated)     20 50      
BB+ to B−     50 100      
Below B−     150 150      
Residential mortgages – fully secured 50 35 35     −61.5 −72.7
Retail lending (consumer) 100 75 75     (−6.5 to −74.3) (−35.2 to −78.6)
Corporate & commercial real estate 100 100       (−21.9 to −41.4 (−29.7 to −52.5)
AAA to AA−     20        
A+ to A−     50        
BBB+ to BB− (& unrated)     100        
Below BB−     150        

Notes: QIS-4 – Fourth Quantitative Impact Study; MRC – minimum capital requirement; MDBs – multilateral development banks

Sources: BCBS (1988, 2004, 2006); FDIC (2005); author commentary